Nomura Capital Goods

ANCHOR REPORT
India capital goods

EQUITY RESEARCH
Assessing earnings risk
October 12, 2011 Research analysts India Capital Goods Amar Kedia - NFASL amar.kedia@nomura.com +91 22 4037 4182 Indrajit Yadav - NSFSPL indrajit.yadav@nomura.com +91 22 4037 4992
Looking beyond the clouds: Assessing the sector amid global/domestic uncertainty
The investment cycle is slowing owing to structural and cyclical stress: policy logjams, interest rates, commodity prices. Things could get worse before they improve, and we have cut numbers. Looking beyond the near-term pain, we pick companies that have strong business models and the most attractive risk-reward positioning. CRG, VOLT and TMX are the top BUYs in our coverage. Critically, these companies share a history of experienced management. BHEL (NEUTRAL) remains at risk, despite now fair valuation. We keep our REDUCE call on ABB India. Key analysis in this anchor report includes:
Study of Indias capex cycle since the 1990s. DuPont analysis-based forensics for individual companies. What is consensus pricing in? What do valuations imply?
See Appendix A-1 for analyst certification and important disclosures. Analysts employed by non-US affiliates are not registered or qualified as research analysts with FINRA in the US.
India capital goods

ELECTRICAL EQUIPMENT
EQUITY RESEARCH
ANCHOR REPORT: Assessing earnings risk
October 12, 2011
Looking beyond the clouds: Assessing the sector amid global / domestic uncertainty
Investment cycle slowing due to mix of structural and cyclical woes Indias investment cycle has suddenly and substantially slowed on the back of several macro headwinds such as policy logjams, and rising interest rates and commodity prices. While the policy logjams on infrastructure-related capex and even on some large-ticket industrial projects are structural issues that need to be addressed by the Government, interest rates and commodity prices are worries that emerge as part of economic cycles. Indias infrastructure need and opportunity is undeniable, but things could get worse before getting better Our economists expect inflation to come down to 6.8% by March 2012, and hence the RBI taking a pause in the rate hikes cycle. Coupled with the fact that India is chronically underinvested in infrastructure, we maintain our long-term positive outlook on the sector. However, a nervous global market implies a worsening of the situation before it turns for the better. Further, internal issues such as the slow pace of reforms and fuel shortages will also continue to hurt sector growth over the medium term, in our view. Firms that could emerge stronger from impending shocks As we maintain a negative view on the possibility of a near-term fix to the internal structural problems, we would avoid stocks such as BHEL, where we see greater risk of a continued slowdown. While we expect the rest of our stocks to likely escape the current turmoil in the investment cycle from the policy logjams, at least partially, the impact from a worsening global macro environment is difficult to predict. We thus assess potential earnings risk for these stocks, and highlight those with significant risk already priced in and/or those better placed to withstand the cyclical shocks. We provide read-across by looking at similar historical data at Bharat Electronics, BEML, AIA Engineering, Carborundum and Blue Star (all not rated). Our picks: CRG, VOLT and TMX Based on an analysis of the above fundamentals, we believe CRG and VOLT (both still BUY) and TMX (upgraded to BUY) have already priced in significant earnings risk despite their compelling businesses. We see continued near-term downside for ABB (still REDUCE), BHEL (NEUTRAL from Reduce) and KKC (still NEUTRAL) from current levels, though we think KKC would bounce back from any correction from current levels.
Fig. 1: Stocks for action
Company Crompton Greaves Thermax Voltas ABB India Bloomberg Ticker CRG IN TMX IN VOLT IN ABB IN Nomura Rating BUY BUY BUY REDUCE Stock Price 149 418 105 666 Target Price 240 500 150 525 Upside/ Downside (%) 61% 20% 43% -21%
Anchor themes The investment cycle in India has been disappointing, on various external and internal issues. While we remain constructive from a long-term perspective, worsening macro conditions could drive further risks before things get better. In this context, we identify companies that are best placed to handle the situation. Nomura vs consensus We have an out-of-consensus Buy call on CRG with a TP that is 25% higher than mean.
Research analysts India Capital Goods Amar Kedia - NFASL amar.kedia@nomura.com +91 22 4037 4182 Indrajit Yadav - NSFSPL indrajit.yadav@nomura.com +91 22 4037 4992
Prices as of 7th October. Source: Nomura Estimates
See Appendix A-1 for analyst certification and important disclosures. Analysts employed by non US affiliates are not registered or qualified as research analysts with FINRA in the US.
Rating: See report end for details of Nomuras rating system.
Nomura | India capital goods
October 12, 2011
Contents
3
Executive Summary Sector valuation summary Scenario analysis: What if the US and Europe slip back into recession? Bharat Heavy Electricals Crompton Greaves Cummins India Voltas Thermax ABB India Bharat Electronics (BHE IN, Not Rated) BEML (BEML IN, Not rated) AIA Engineering (AIAE IN, Not rated) Carborundum Universal (CU IN, Not rated) Blue Star (BLSTR IN, Not rated) Appendix A-1
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October 12, 2011
Executive Summary
India is currently witnessing a mix of structural and cyclical pressures in the capex cycle
We note that FY04 to FY08 witnessed an unparalleled capex boom in India fuelled by easing policies, fund availability and a continued demand/supply mismatch, among others. On the back of this, we estimated Indias infrastructure investment opportunity over FY11-15F to be about US$600bn in our Anchor report titled, Different strokes, dated 12 August, 2010. However, sentiments have been dented in general over the past 12 months. While a slowdown in the investment cycle is not an aberration per se for any economy, factors driving the slowdown are important to analyse. For the India infrastructure sector, we see a mix of structural and cyclical factors plaguing near- to medium-term visibility -- first, the aftermath of Lehman bankruptcy that continues to haunt the world macro environment, and then the deteriorating pace of policy initiatives in the infrastructure sector by the existing policy makers. Structural constraints mostly related to policy issues We highlighted structural concerns facing the sector in our note Structural bottlenecks ahead, dated 22 April, 2011. These primarily relate to the availability of resources such as land, fuel and funding. Additionally, there could be constraints in the form of unfavourable Government policies such as environmental clearances and uncertainty over the tax regime, among others. Falling competitiveness of the industry could be another driver of a capex slowdown for the respective sector. A slowdown induced by such reasons is a greater reason of concern for us than the typical macro cycle-induced slowdown. We also quote excerpts from our recent report on the infrastructure sector titled, Valuation factors in deterioration in fundamentals, dated 29 September, 2011. Hurdles in environmental clearances and land acquisitions have slowed investments in infrastructure, impacting most sectors. For instance, lack of coal availability due to environmental issues and transportation infrastructure bottlenecks, and state electricity board (SEB) losses have taken the sheen out of the power generation segment. Industrial capex has been muted since FY09, and analyst estimates suggest no material pick up in the near term. Cyclical pressures primarily a function of overcapacity, high commodity prices and rising interest rates Apart from the policy logjam, the macroeconomic environment, too, hasn't been supportive of the capex cycle. Indias current inflation rate at 10% is close to the peak witnessed over the past 15+ years. To counter inflation and inflationary expectations, the Indian central bank (RBI) has responded with repeated monetary tightening over the past several quarters. Specifically, the RBI has taken 12 repo rate hikes, and the current rate, at 8.25%, is 75bps lower than what prevailed just before the post-Lehman crisis period. Similarly, commodity prices are significantly above trend currently (though still below 2008 levels) and pose a significant threat to margins for several capital goods companies. Our view of a typical business cycle is as follows The cyclical upswing in demand is typically followed by a capacity build-up by suppliers in anticipation of continued demand pull. However, most often such capacity addition comes with a lag and by then demand has typically already slowed down. At times, existing suppliers benefit from low existing capacity in the system and thus make extraordinary profits such instances excite more vendors and lead to overcapacity. Some of the notable examples of such behaviour are in the Transmission & Distribution equipment segment as well as in the boiler and turbine segment currently. However, we believe that this overcapacity is only a temporary phenomenon, in most cases, as a revival of demand in general leads to an automatic match-up with capacity. The time
October 12, 2011
frame within which such demand-supply balance is achieved is arguable, nevertheless, and visibility of improvement could be a key determinant of timing the entry into a particular sector.
Fig. 2: WPI inflation peaking out
13.0
Fig. 3: Commodity price Index (CRY Index)

500 450
9.5
400 350
6.0
300 250
2.5
200 150
Apr-95
Apr-97
Apr-99
Apr-01
Apr-03
Apr-05
Apr-07
Apr-09
Apr-11
Source: CEIC, Nomura Global Economics
Apr-13
Source: Bloomberg
Fig. 4: Repo rate (%)

10 9 8
Fig. 5: Short-term interest rate (%)

15 3M 6M 12 12M
9
7 6 5 4 Apr-01
Source: RBI
Apr-03
Apr-05
Apr-07
Apr-09
Apr-11
Source: Bloomberg
Indias infrastructure opportunity is unquestionable, but what if we revert to the pre-capex boom period?
Going forward, our economics team expects inflation to come down to 6.8% by March 2012, primarily driven by the base effect. Accordingly, the team doesn't expect any further tightening by the RBI. A global slowdown will also inevitably lead to a softening of commodity prices from these levels and should be positive for companies in our sector. At the same time, we reiterate our thesis on Indias large infrastructure investment opportunity, though timelines might shift a bit depending on the severity of the slowdown and the continued impasse in domestic policy making. To us, a cyclical slowdown is a normal course of correction so as to protect the economy from overheating and is often driven by a hawkish Central Bank policy stance it is in this sense that it is cyclical. However, the extent to which the global scenario could worsen is difficult to predict. The impact from such a scenario could be worse than our base case estimates and outlook for the sector. It could also mean continued deferral on capex by companies in general,
May-05 Sep-05 Jan-06 May-06 Sep-06 Jan-07 May-07 Sep-07 Jan-08 May-08 Sep-08 Jan-09 May-09 Sep-09 Jan-10 May-10 Sep-10 Jan-11 May-11
4
Jan-95 Oct-95 Aug-96 May-97 Mar-98 Dec-98 Oct-99 Jul-00 May-01 Feb-02 Dec-02 Sep-03 Jul-04 May-05 Feb-06 Dec-06 Sep-07 Jul-08 May-09 Feb-10 Dec-10 Sep-11
-1.0
100
October 12, 2011
and this could materially impact the financial performance of several companies in the sector. Accordingly, we assess earnings risk for companies we cover in the capital goods sector to try to determine those best placed to withstand the current slowdown. Focusing on the complete investment cycle from late 90s We believe that any analysis of the impact of cyclicality on the Indian capital goods sector is meaningless unless one takes into account the full cycle of data from previous lows, which was in the late 1990s. We note that the Street (including ourselves) often compares companies historical financials and valuation ratios for a period of the past 5-6 years with the current dataset. However, given that Indias investment story started in FY04-05, we believe such a comparison would provide a positively biased view, at best. It is thus necessary, in our view, that we take into account data points from the previous cyclical lows to see what happens if capex which took off in FY04-05 all of a sudden stands still for the near term. Even a comparison with the post-Lehman crisis period is unfair, in our view, since that was a period that only impacted credit availability and was not necessarily a cyclical pause in the investment cycle.
Fig. 6: Investment cycle took off in a big way only around FY04
Corporate Capex Index (indexed to 1995; metals on RHS)
4,500 3,600 2,700 1,800 900 0

1995 1996 1997
BSE500 Oil & gas Auto & Auto Parts Power
Infra Telecom Cement Metals
7,000 6,000 5,000 4,000 3,000 2,000 1,000 0
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
Source: Ace Equity, Nomura research
While we do not attempt to predict what stage of the cycle these companies are currently in and how long the adversities could continue, we do attempt to analyse the impact from such adversities, if any. We also attempt to see which stocks are best positioned to withstand the pressure from internal and external shocks, as highlighted earlier. In this context, we have also segregated companies that we believe could be suffering from internal structural issues such as a policy logjam. We would recommend avoiding stocks that are plagued by such structural issues even if their valuations appear attractive.
2011
October 12, 2011
Our preferred picks: CRG, TMX and VOLT

Our methodology for the purpose of this analysis evolves from the DuPont analysis framework. We start with comparing the historical ROE/ROCE for a particular company and then try and find out reasons why the ROE/ROCE has expanded or collapsed over the time period for that particular company.
Fig. 7: Typical DuPont equation
Source: Nomura research
As depicted in the equation above, ROE is primarily a function of operating margin, tax burden, asset turnover and financial leverage. Of these, we do not focus on tax burden, since for companies in our coverage tax rates have not been a big driver of ROE and further it is not of a predictable nature. We also exclude the impact of financial leverage from our consideration, since most of the companies in the capital goods space have had very little financial leverage. a) b) c) d) Our key focus thus is on profit margin, and Asset turnover trends for these companies, over the analyzed timeframe. We further break-up asset turnover analysis into working capital management and sales trends, to find out whether the asset turnover ratios benefit merely from sales growth or is there a genuine effort by the management to keep working capital in check.
Based on the above framework, we analyse how well are the companies placed to sustain risks from an impending slowdown be it internal or external factors induced. Below table summarizes key trend observed by us for each of the companies over the available financial history of 12 years.
Fig. 8: Identifying companies that have efficiently managed their balance sheet across the cycle
Shaded area highlights companies that have excelled as per the respective criteria
ABB ROE ROCE Asset Turnover Asset Turnover Ex-Cash Working Capital Cycle
AIAE
BEML
BHE
BHEL
BLSTR
CRG
CU
KKC
TMX
VOLT
Our next step entailed a comparison of what the consensus estimates are building in for the stocks we cover now versus what they were building in at the peak of the cycle. We then compared this with the earnings risk that we see for these companies based on the business strength gauged from the above analysis. The below chart summarizes our findings of earnings risk that is already anticipated by consensus vs. what it could be over and above this.
October 12, 2011
Fig. 9: While consensus estimates are down sharply, we see further risk for most companies
%
30% 25%
Risk of Further Correction
KKC
ABB
20% 15% 10% 5% 0% 0% 5% 10% 15%

Consensus Earnings Cut Back (%) BHEL TMX VOLT CRG
20%
25%
30%
35%
Shaded area highlights companies that are preferred based on the above criteria; axis divided on the basis of observed median for the analysed companies Source: Bloomberg, Nomura estimates
Cognizant of the current expectations of earnings risk and business strength (or structural constraints that it is facing as the case may be), we try to interpret how much of this risk is already priced into the stocks and thus identify opportunities. Based on our analysis, we find a few stocks that exhibit traits that we were looking for to qualify them as investible ideas based on: valuations already factoring in significant near-term earnings risk; relatively low earnings risk here onwards; and balance sheet strength and/or superior earnings quality. We have also segregated stocks that, in our view, are subject to structural slowdown risks as discussed earlier notably BHEL. The figures below summarize our findings based on these parameters.
Fig. 10: Stocks trading below 12-year mean levels are few
1 year forward multiple over 12 year mean multiple (x)
1.3
1 yr fwd P/B
KKC
1.0
BHEL
0.7
ABB CRG VOLT
1 yr fwd P/E
TMX
0.4 0.4 0.7 1.0 1.3 1.6

Shaded area highlights companies that are trading below 12 year mean levels across both the parameters; axis divided on the basis of observed median for the analysed companies Source: Bloomberg, Nomura research
October 12, 2011
Fig. 11: Identifying companies that are largely pricing in earnings risk
Dark shades highlight most preferred companies, while light shades are preferred upon correction
ABB Relative valuation Risk to earnings Balance sheet strength/ Earnings quality Concerns: Structural (S) / Cyclical (C) Our preference
BHEL
C x
S x
CRG C
KKC
TMX C
C -
VOLT C
Accordingly, we highlight CRG, TMX and VOLT as stocks that are currently pricing in significant earnings risk while being strong businesses at the same time, and these would be our preferred investment ideas. Apart from these, we single out KKC for exhibiting excellent efforts in containing the impact of business cyclicality by way of efficient working capital management and thus sustainably high ROE/ROCE. We would highlight KKC as a stock that may be prone to near-term downside due to expensive valuation or earnings risk not yet factored in by the Street, but would keep it in the radar in case of correction. On the other hand, we see continued downside risks for BHEL and ABB on account of multiple factors such as structural concerns and/or expensive valuation/earnings risk/relatively inefficient balance sheet management.
October 12, 2011
Sector valuation summary

Fig. 12: India Capital Goods sector valuation comps
P/E (x) Price BHEL ABB India Cummins India Crompton Greaves Thermax Larsen & Toubro@ Voltas Covered companies' average Siemens India* Areva T&D India* AIA Engineering* BEML Ltd* Bharat Electronics* Carborundum Universal* Blue Star* Sector Average SENSEX
Pricing as of October 7, 2011 * Bloomberg consensus estimates for non rated companies (see below exhibit for ratings). ABB India and Areva T&D India FY11/12/13 correspond with CY10/11/12 estimates, while Siemens India FY11/12/13 is average of Sep-10/11/12/13 and Sep-11/12/13/14 estimates respectively. # Averages for P/E, EPS CAGR and ROE do not include ABB India given highly volatile trend. @ L&T P/E, ROE and EPS adjusted for subsidiary valuation and earnings Source: Bloomberg, Nomura estimates
P/BV (x) FY13F 11.3 30.9 15.8 9.6 12.7 11.0 10.8 11.9 23.9 18.1 12.6 6.8 11.5 6.4 9.8 12.3 FY11 3.9 5.9 6.2 3.0 3.8 2.4 2.5 3.7 7.7 5.2 2.8 0.9 2.4 1.9 3.9 3.6 FY12F 3.2 5.3 5.4 2.5 3.1 2.2 2.1 3.1 6.4 4.5 2.4 0.9 2.1 1.5 3.4 3.0 FY13F 2.7 4.6 4.7 2.1 2.6 1.9 1.8 2.6 5.2 3.4 2.1 0.8 1.8 1.3 2.9 2.6
EPS CAGR FY09-11 12% -49% 18% 29% 15% 15% 12% 17% 14% -12% 2% -9% 3% 28% -5% 9% 17% FY11-13F 15% 81% 11% 5% 1% 20% 1% 9% 18% 29% 13% 13% 15% 12% 13% 13% 13% FY11 33.3 2.6 35.1 32.1 31.9 19.7 29.2 30.2 25.7 18.0 18.6 11.8 16.8 22.4 27.0 24.7
ROE (%) FY12F 29.1 12.1 35.5 21.8 28.2 19.6 21.7 26.0 25.4 19.9 17.4 9.7 17.1 21.2 25.0 22.4 FY13F 26.1 15.9 31.7 23.9 22.4 19.8 18.4 23.7 24.6 21.1 17.7 12.4 16.9 21.4 29.1 22.0
FY11 14.9 101.6 19.5 10.7 13.1 15.9 10.9 14.2
FY12F 12.2 45.7 17.3 12.7 12.1 13.2 12.9 13.4 28.4 23.5 14.8 9.1 12.9 7.6 12.6 14.6
325 666 406 149 418 1,393 105
837 219 311 468 1,519 148 222
33.1 30.2 16.1 8.7 15.2 8.1 12.4 16.1
Fig. 13: India Capital Goods sector performance and rating comparison
Nomura Rating BHEL ABB India Cummins India Crompton Greaves Thermax Larsen & Toubro Voltas Siemens India Areva T&D India AIA Engineering BEML Ltd Bharat Electronics Carborundum Universal Blue Star Sector Average NIFTY SENSEX
Note: pricing as of October 7, 2011
# of Recommendations Buy 21 0 12 19 14 34 19 3 4 4 4 8 4 3 Sell 4 34 7 14 6 3 3 9 6 2 0 0 1 3 Hold 15 2 3 11 15 3 5 6 3 3 0 1 2 6
Stock price performance over 1m (8.4) (22.8) (7.4) (2.0) (3.6) (18.6) (16.0) (4.0) (4.0) (9.9) (0.2) (5.0) (1.4) (12.1) (8.2) (5.1) (5.4) 3m (18.2) (22.6) (15.9) (43.1) (34.4) (25.2) (37.1) (6.3) (14.7) (16.2) (23.2) (8.9) (2.5) (28.3) (21.2) (14.7) (5.6) 6m (26.0) (17.4) (18.1) (48.2) (40.4) (16.6) (42.5) (6.5) (19.1) (13.2) (38.3) (16.9) 21.8 (41.5) (23.1) (17.0) (17.1) 12m (37.6) (28.8) (22.4) (55.3) (42.1) (31.6) (56.6) 2.0 (31.8) (25.2) (59.4) (19.0) 26.9 (55.4) (31.2) (20.1) (20.1)
NEUTRAL REDUCE NEUTRAL BUY BUY BUY BUY Not Rated Not Rated Not Rated Not Rated Not Rated Not Rated Not Rated
Source: Bloomberg, Nomura estimates
October 12, 2011
Fig. 14: Earnings estimates: Nomura vs consensus (Rs mn)

FY12F Nom ura Consensus BHEL ABB India Cummins India Crompton Greaves Thermax Larsen & Toubro@ Voltas 65,194 3,112 6,918 7,830 4,127 44,344 2,696 66,637 3,260 6,848 7,230 4,220 43,392 3,384 Difference -2% -5% 1% 8% -2% 2% -20% Nom ura 70,591 4,604 7,113 10,302 3,912 52,893 3,222 FY13F 74,496 4,884 7,342 9,230 4,788 50,986 3,887 -5% -6% -3% 12% -18% 4% -17% 75,396 5,854 8,725 12,578 4,671 62,041 3,964 FY14F 73,345 6,184 8,369 10,603 5,314 60,070 4,486 3% -5% 4% 19% -12% 3% -12%
Consensus Difference Nom ura Consensus Difference
Source: Bloomberg, Nomura estimates
10
October 12, 2011
Scenario analysis: What if the US and Europe slip back into recession?
As the markets have been signaling that risks to our baseline forecasts are on the downside, our global economics team have considered a bear case economic scenario, most obviously triggered by a market meltdown, but the fragile state of the advanced economies leaves them vulnerable to unforeseen shocks or policy errors. For details, see Global Weekly Economic Monitor, 12 August 2011, and Global market turbulence: Implications for Asia, 9 August 2011. The bear case scenario assumes: The US and Euro area slip back into recession, with US GDP averaging -1% saar in 2H11 and Euro GDP averaging -3% before recovering to around 2% growth in 2012. The CRB commodity price index falls 15% between now and year-end, but starts rising back again through 2012 reaching current levels by end-2012. If there is a market meltdown and recessions in the US and euro area, we have no doubt that initially many economies in the region would be hit hard again in an echo of the global financial crisis, as non-linear effects start to kick in, notably financial decelerator effects, multiplier effects of weakening exports on domestic capex and jobs, and capital flight. However, less disturbing this time around are the two factors that there is less leverage in the financial system (less room for capital flight) and less chance of Asian trade finance drying up, as the worlds central banks have most likely learnt the need to provide ample USD liquidity through FX swap arrangements. In this scenario, we find Hong Kong, Singapore, Malaysia and Taiwan to be among the most vulnerable. But, as in 2009, we would expect that, over time, powerful tailwinds would develop, allowing Asia to bounce back before other regions. These tailwinds include a likely further decline in commodity prices and the ample room Asia has to ease monetary and fiscal policies more so than any other region. In our bear case scenario, we would expect the Fed to resort to further quantitative easing, which once again would likely precipitate strong net capital inflows into Asia, attracted by stronger growth, superior fundamentals and higher interest rates relative to other regions. What if things get even worse than we can foresee? Although our global economics team does not see such a situation as plausible at the moment, they have run an extreme-case scenario analysis to provide some perspective. This extreme scenario assumes: US GDP averaging about -4% saar in 2H11 and Euro GDP averaging -6.5% before recovering to around 1% growth in 2012. CRB commodity price index falls 40% between now and year-end, and stays at the lower level through 2012.
11
October 12, 2011
The table below summarises both the official bear case and the hypothetical extreme case scenarios.
Fig. 15: Real GDP growth forecasts: baseline and downside scenarios
2011F Base case 2.2 9.5 5.4 7.7 6.5 4.7 2.2 5.1 5.6 3.5 4.5 4.1 6.4 7.9 Bear case 1.5 9.0 4.4 7.0 6.0 4.0 1.8 4.7 4.3 2.5 3.6 3.5 6.0 7.2 Extreme case 0.9 8.5 3.4 6.5 4.8 1.0 1.4 3.3 1.5 1.5 2.4 0.6 4.5 6.4 Base case 4.6 8.6 4.5 7.9 7.0 5.1 3.5 5.7 5.3 5.0 5.0 4.7 6.9 7.6 2012F Bear case 3.5 8.8 4.0 7.6 6.8 4.8 3.5 5.3 5.1 5.0 4.9 4.5 6.5 7.6 Extreme case 3.3 6.0 1.2 7.0 4.0 -0.4 3.3 2.4 -1.8 2.5 0.9 -0.5 4.2 5.1
Australia China Hong Kong India Indonesia Malaysia New Zealand Philippines Singapore South Korea Taiwan Thailand Vietnam Asia ex Japan, Aus, NZ
The global bear case does not look bad for much of Asia and in fact is marginally better than the base case for China in 2012 because we would expect a Vshape rebound for the region thanks to the likely decline in commodity prices and the ample room Asia has to ease monetary and fiscal policies. We would also expect the Fed to resort to further quantitative easing, which once again would likely precipitate strong net capital inflows into Asia. In the extreme case, however, even these strengths will be tested.
Source: CEIC and Nomura Global Economics. Units: % y-o-y
12
Bharat Heavy Electricals

BHEL.NS BHEL IN
EQUITY RESEARCH
No relief in sight, but reaching fair valuation
October 12, 2011 Rating Up from Reduce Target price Reduced from 346 Closing price October 7, 2011 Potential upside
Medium-term concerns remain, and stock price factors in lack of potential orders
Action: Upgrade to NEUTRAL rating While we remain extremely concerned about near-term order inflow for the sector and also foresee continued execution delays for BHEL, we believe that, at current levels, the stock is now extrapolating these concerns beyond the visible horizon. We believe that there is an equal probability of improvement in the sectors fortunes (most notably related to policy reforms on SEB health and land & fuel availability) post this visible horizon and that, as such, downside from current levels is limited. Catalysts: Orders, results, macro and policy action We view continued earnings and/or order misses compared to Street estimates and defaults by developers or state utilities as negative triggers, while softening commodity prices and policy reforms are upside catalysts. Our view ties up with historical study: strongly positioned for upturn but sector woes plague visibility in the medium term FY11 margin levels are at the peak of the cycle and suggest downside risks, especially with the incoming competition and slowing growth. This is largely built into our estimates now. Valuation: Trading at 11x FY13F EPS; close to pre-FY05 boom Valuation is below BHELs mid-cycle trading range, but is still higher than pre-utility capex boom levels. We do not rule out BHEL reverting to preFY05 multiples, but the possibility of improvement in order activity in 1218m suggests that such a severe correction would be brief. Tweaking estimates for further execution delays and minor relief in raw-material cost.
31 Mar Currency (INR) FY11 Actual Old FY12F New Old FY13F New Old FY14F New
Neutral
INR 332 INR 325 +2.2%
Anchor themes Even as demand for power is unlikely to slow, we expect actual power capacity to be constrained by limitations on land & fuel availability and environmental clearances. Nomura vs consensus Our FY12-13F EPS is lower than consensus by 2-5%, as we expect order deferrals to impact execution. We are also concerned about margins due to rising competition.
Revenue (mn) Reported net profit (mn) Normalised net profit (mn) Normalised EPS Norm. EPS growth (%) Norm. P/E (x) EV/EBITDA (x) Price/book (x) Dividend yield (%) ROE (%) Net debt/equity (%)
397,227 463,449 466,580 553,147 547,217 60,114 53,552 21.88 24.4 14.9 8.7 3.9 2.2 33.3 64,423 64,423 26.32 20.3 N/A 6.9 N/A N/A 28.8 65,194 65,194 26.64 21.7 12.2 7.2 3.2 2.5 29.1 70,320 70,320 28.73 9.2 N/A 6.2 N/A N/A 26.0 70,591 70,591 28.84 8.3 11.3 6.4 2.7 2.8 26.1 N/A N/A N/A
608,999 75,396 75,396 30.80 6.8 10.6 5.9 2.3 2.9 23.5 net cash
net cash net cash net cash net cash net cash
Source: Nomura estimates, BHEL stock split in 5:1 ratio effective 3 October, 2011.
See Appendix A-1 for analyst certification, important disclosures and the status of non-US analysts.
Key company data: See page 2 for company data and detailed price/index chart.
Nomura | Bharat Heavy Electricals
October 12, 2011
Key data on Bharat Heavy Electricals

Incomestatement(INRmn)
Year-end 31 Mar Revenue Cost of goods sold Gross profit SG&A Employee share expense Operating profit EBITDA Depreciation Amortisation EBIT Net interest expense Associates & JCEs Other income Earnings before tax Income tax Net profit after tax Minority interests Other items Preferred dividends Normalised NPAT Extraordinary items Reported NPAT Dividends Transfer to reserves Valuation and ratio analysis FD normalised P/E (x) FD normalised P/E at price target (x) Reported P/E (x) Dividend yield (%) Price/cashflow (x) Price/book (x) EV/EBITDA (x) EV/EBIT (x) Gross margin (%) EBITDA margin (%) EBIT margin (%) Net margin (%) Effective tax rate (%) Dividend payout (%) Capex to sales (%) Capex to depreciation (x) ROE (%) ROA (pretax %) Growth (%) Revenue EBITDA EBIT Normalised EPS Normalised FDEPS Per share Reported EPS (INR) Norm EPS (INR) Fully diluted norm EPS (INR) Book value per share (INR) DPS (INR)
Source: Nomura estimates
Notes FY10 337,894 -208,431 129,463 -7,214 -64,492 57,757 62,337 -4,580 57,757 -335 8,412 65,834 -22,800 43,034 FY11 397,227 -243,567 153,661 -22,791 -56,512 74,358 80,267 -5,909 74,358 -547 6,418 80,228 -26,676 53,552 FY12F 466,580 -289,304 177,276 -26,884 -60,128 90,264 97,552 -7,288 90,264 -547 8,319 98,036 -32,842 65,194 FY13F 547,217 -349,091 198,126 -31,331 -67,080 99,715 107,407 -7,692 99,715 -547 7,788 106,955 -36,365 70,591 FY14F 608,999 -393,888 215,110 -34,879 -73,600 106,632 114,654 -8,022 106,632 -547 8,152 114,236 -38,840 75,396
Revenue growth rate has already slowed to sub 18% from high twenties as base effect catches up and on execution delays.
43,034 73 43,106 -13,321 29,786
53,552 6,562 60,114 -17,841 42,273
65,194 0 65,194 -20,213 44,980
70,591 0 70,591 -21,887 48,704
75,396 0 75,396 -23,377 52,019
18.5 18.9 18.5 1.7 34.3 5.0 11.2 12.1 38.3 18.4 17.1 12.8 34.6 30.9 5.3 3.9 29.9 17.4
14.9 15.2 13.2 2.2 18.1 3.9 8.7 9.4 38.7 20.2 18.7 15.1 33.3 29.7 4.6 3.1 33.3 17.6
12.2 12.5 12.2 2.5 28.9 3.2 7.2 7.8 38.0 20.9 19.3 14.0 33.5 31.0 2.6 1.6 29.1 17.8
11.3 11.5 11.3 2.8 16.8 2.7 6.4 6.9 36.2 19.6 18.2 12.9 34.0 31.0 1.8 1.3 26.1 17.8
10.6 10.8 10.6 2.9 20.2 2.3 5.9 6.4 35.3 18.8 17.5 12.4 34.0 31.0 1.1 0.9 23.5 17.5
Relative performance chart (one year)

(INR) 550 500 450 400 350 300 M ay 11 Dec 10 J un 11 M ar 11 J ul 11 A ug 11 S ep 11 F e b 11 O c t 11 N ov 1 0 J an 11 A pr 11 Price Rel MSCI India 105 100 95 90 85 80 75
Source:ThomsonReuters,Nomuraresearch
25.7 42.0 42.4 37.6 37.6
17.6 28.8 28.7 24.4 24.4
17.5 21.5 21.4 21.7 21.7
17.3 10.1 10.5 8.3 8.3
11.3 6.7 6.9 6.8 6.8
(%) Absolute (INR) Absolute (USD) Relative to index Market cap (USDmn) Estimated free float (%) 52-week range (INR)
1M
3M 12M
-8.4 -19.7 -40.8 -14.7 -27.7 -46.4 -3.7 15,548.6 22.3 539/309.5 33.67 -3.7 -16.5
17.61 17.58 17.58 65.03 5.44
24.56 21.88 21.88 82.34 7.29
26.64 26.64 26.64 100.72 8.26
28.84 28.84 28.84 120.62 8.94
30.80 30.80 30.80 141.87 9.55
3-mth avg daily turnover (USDmn) Major shareholders (%) President of India LIC
67.7 4.4
Source: Thomson Reuters, Nomura research
14
October 12, 2011
Cashflow(INRmn)
Year-end 31 Mar EBITDA Change in working capital Other operating cashflow Cashflow from operations Capital expenditure Free cashflow Reduction in investments Net acquisitions Reduction in other LT assets Addition in other LT liabilities Adjustments Cashflow after investing acts Cash dividends Equity issue Debt issue Convertible debt issue Others Cashflow from financial acts Net cashflow Beginning cash Ending cash Ending net debt
FY10 62,337 -24,495 -14,651 23,191 -17,756 5,436 -275 0 3,131 8,291 -13,321 -216 FY11 80,267 -22,182 -14,244 43,841 -18,091 25,750 -3,593 0 -6,363 92 15,886 -17,841 356 FY12F 97,552 -49,598 -20,414 27,541 -12,000 15,541 0 0 0 15,541 -20,213 0 FY13F 107,407 -30,822 -29,124 47,460 -10,000 37,460 0 0 0 37,460 -21,887 0 FY14F 114,654 -44,012 -31,236 39,406 -7,000 32,406 0 0 0 32,406 -23,377 0 Notes
Net addition to cash is under pressure as rising working capital is straining operating cash flow.
-13,537 -5,246 103,147 97,901 -96,623
-17,485 -1,599 97,901 96,302 -94,668
-20,213 -4,672 96,302 91,629 -89,995
-21,887 15,574 91,629 107,202 -105,569
-23,377 9,029 107,202 116,231 -114,598
Balancesheet(INRmn)
As at 31 Mar Cash & equivalents Marketable securities Accounts receivable Inventories Other current assets Total current assets LT investments Fixed assets Goodwill Other intangible assets Other LT assets Total assets Short-term debt Accounts payable Other current liabilities Total current liabilities Long-term debt Convertible debt Other LT liabilities Total liabilities Minority interest Preferred stock Common stock Retained earnings Proposed dividends Other equity and reserves Total shareholders' equity Total equity & liabilities Liquidity (x) Current ratio Interest cover Leverage Net debt/EBITDA (x) Net debt/equity (%) Activity (days) Days receivable Days inventory Days payable Cash cycle
FY10 97,901 0 206,888 92,355 32,205 429,348 798 39,450 0 0 0 469,596 75,798 248,619 324,417 1,278 -15,272 310,422 0 4,895 154,278
FY11 96,302 0 273,546 109,630 35,469 514,947 4,392 51,631 0 0 0 570,971 96,000 293,434 389,434 1,634 -21,636 369,432 0 4,895 196,643
FY12F 91,629 0 310,799 128,193 42,654 573,274 4,392 56,343 0 0 0 634,009 113,690 289,145 402,836 1,634 -16,979 387,490 0 4,895 241,624
FY13F 107,202 0 328,062 150,348 38,850 624,462 4,392 58,651 0 0 0 687,505 115,623 292,003 407,627 1,634 -16,979 392,282 0 4,895 290,328
FY14F 116,231 0 365,100 167,322 42,644 691,297 4,392 57,629 0 0 0 753,318 130,787 290,634 421,421 1,634 -16,979 406,076 0 4,895 342,347
Notes
Rising working capital pressure to hurt return ratios as cash cycle elongates.
159,174 469,596
201,538 570,970
246,519 634,009
295,223 687,505
347,242 753,318
1.32 172.4
1.32 135.9
1.42 164.9
1.53 182.2
1.64 194.8
net cash net cash
net cash net cash
net cash net cash
net cash net cash
net cash net cash
198.0 149.5 117.6 229.9
220.7 151.3 128.7 243.3
229.2 150.4 132.6 247.0
213.1 145.6 119.9 238.8
207.7 147.2 114.2 240.7
15
October 12, 2011
How well is BHEL positioned for a turn in the cycle?

Balance sheet and return efficiency
Consistency of return ratios BHELs return ratios have risen significantly over the past eight years mainly due to rising EBITDA margins, steady growth and a falling working-capital cycle. However, as we discuss later, all of these factors are at substantial risk of reversal over the medium term, in our view.
Fig. 16: BHEL: ROE has consistently been rising
ROE 40% 35% 30% 25% 20% 15% 10% 5% 0%
Fig. 17: and so has ROCE

ROCE
35% 30% 25% 20% 15% 10% 5% 0%
FY99
FY00
FY01
FY02
FY03
FY04
FY05
FY06
FY07
FY08
FY09
FY10
FY99
FY00
FY01
FY02
FY03
FY04
FY05
FY06
FY07
FY08
FY09
FY10
Source: Company, Nomura research
FY11
Management of working capital and asset turnover Asset turnover ex cash has come back to late 1990s levels despite a falling workingcapital cycle. Asset turnover, including cash, is already worse and is gradually declining. This is primarily due to unproductive use of cash in the balance sheet, in our view. We think that without a supportive working-capital cycle the asset turnover trend for the company would have been worse. Even the fall in the working-capital cycle appears to be due mainly to rising customer advances and is only partly alleviated by a fall in the inventory cycle. We see no clear trends from the receivable cycle.
FY11
16
October 12, 2011
Fig. 18: Asset turnover has declined over the period despite a falling working-capital cycle
(x) 0.9 0.8 0.8 0.7 0.7 0.6 Asset turnover
Fig. 19: though asset turnover ex cash has been better, even that is now under threat
(x) 1.05 1.00 0.95 0.90 0.85 0.80 0.75 0.70 0.65 Asset turnover (ex cash)
FY99
FY00
FY01
FY02
FY03
FY04
FY05
FY06
FY07
FY08
FY09
FY10
FY11
FY99
FY00
FY01
FY02
FY03
FY04
FY05
FY06
FY07
FY08
FY09
FY10
Fig. 20: Fall in working-capital cycle driven mainly by rising customer advances; also aided by better inventory
Days of revenue
250 200 150 100 50 0 -50
Net working capital cycle
FY99
FY00
FY01
FY02
FY03
FY04
FY05
FY06
FY07
FY08
FY09
FY10
Trajectory of growth BHELs sales growth has ranged from 20-30% since FY05 when the utility capex boom started. At the same time, margins started to improve, possibly due to operating leverage benefits. The dip in FY09 margins was mainly due to provisioning for staff cost hikes. However, our fundamental concerns about slowing growth for BHEL and margin pressure, both emanating from rising competition and slowing utility capex, could imply a reversal of the trend that we have been seeing since FY05.
FY11
FY11
17
October 12, 2011
Fig. 21: Strong sales growth aided in strong return ratios
Fig. 22: Rise in EBITDA margins is the key driver of improvement in return ratios
% of revenues
FY99
FY00
FY01
FY02
FY03
FY04
FY05
FY06
FY07
FY08
FY09
FY10
FY99
FY00
FY01
FY02
FY03
FY04
FY05
FY06
FY07
FY08
FY09
FY10
FY11
Risks from adverse turn in the cycle

Sales and margin trends suggest that the business is close to peak-cycle levels in this case it co-relates with the utility capex cycle. Fundamentally, we believe that BHELs existing order book should allow it to benefit for another 2 years or so. Risks to sales We see an imminent risk of a sales slowdown for BHEL on account of slowing orders, rising competition, and execution delays. Risk to margins Margin risk is clearly visible as, prior to the utility capex boom, BHEL margins were <15% compared to current levels of 20%. A slowdown in sales would also lead to reversal of benefits due to operating leverage, in our view.
What are consensus estimates building in?

Consensus EPS estimates for BHEL have been flat over the past 12 months and have yet to factor in any risk of execution delays, in our view. Nevertheless, upside risks are also possible for BHEL from any slowdown in commodity prices, as a significant share of its projects are on a fixed-price basis.
FY11
18
45% 40% 35% 30% 25% 20% 15% 10% 5% 0% -5% -10%
Sales growth
(x) 25% 20% 15% 10% 5% 0%
EBITDA margin
October 12, 2011
Fig. 23: Consensus estimates have yet to factor in execution risks

(INR) 170 165 160 155 150 145 140 135 130 125 Consensus EPS FY12 Consensus EPS FY13
Nov-09
May-09
May-10
Nov-10
Oct-09
Apr-09
Aug-09
Sep-09
Apr-10
Aug-10
Sep-10
Dec-09
Oct-10
Dec-10
Jun-09
Jan-10
Jun-10
Feb-10
Source: Bloomberg
What is the valuation factoring in?

BHEL is currently trading below its 12-year mean on P/E and slightly below its 12-year P/BV mean. However, we note that it is still trading above its trading range during the pre-utility capex boom period, i.e., prior to FY05. BHELs re-rating since FY05 has been due mainly to the utility capex pick-up story and BHELs monopoly status, which helped it increase margins and ROEs. In the current context, all of these favourable arguments are diminishing for BHEL and hence, we do not expect any re-rating at this time.
Fig. 24: Stock trading below 12-yr P/E mean, but in line with mean multiples pre-utility capex boom (-1 STDEV)
BHEL 1 year forward P/E chart
Mar-10
Fig. 25: On P/BV, stock is still close to 12-yr mean and well above pre-utility capex boom multiples
BHEL 1 year forward P/B chart
(x) 50 45 40 35 30 25 20 15 10 5 0
Mar-00 Mar-01 Mar-02
1 yr fwd P/E chart +1STDEV Mean -1STDEV
(x) 12 10 8 6 4 2 0
1 yr fwd P/B chart Mean
Jan-11
Jul-09
Jul-10
+1STDEV -1STDEV
Mar-03
Mar-04
Mar-05
Mar-06
Mar-07
Mar-08
Mar-09
Mar-10
Mar-11
Mar-00
Mar-01
Mar-02
Mar-03
Mar-04
Mar-05
Mar-06
Mar-07
Mar-08
Mar-09
Mar-10
Source: Company, Bloomberg, Nomura estimates
Impression: Strongly positioned on balance sheet, though downside risks on margins and working-capital cycle
Our evaluation is based on FY11 margin levels being at the peak of the cycle and suggest downside risks, especially with the upcoming competition and slowing growth; Slower order flow will lead to slower sales growth. This will also be impacted by rising competition and execution delays, in our view;
Mar-11
19
October 12, 2011
While valuation is below the mid-cycle trading range, it is still much higher than preutility capex boom period trading range. We would expect BHEL stock to revert to the multiples at which it used to trade pre FY05, and that would imply continued downside from current levels.
Tweaking estimates and TP; upgrade to NEUTRAL

As we build in further execution delays and minor near-term relief from softening commodity prices, our FY12 and FY13 estimates rise 2-3%. However, we build in further cuts in medium-term margin estimates, i.e., beyond FY13, to factor in rising competition. Together with the impact of these changes and rolling over to Sep-12, we arrive at our new TP of INR332.
Valuation methodology
We continue to value BHEL using a discounted cashflow (DCF) methodology, assuming a cost of equity of 12% and a terminal growth rate of 4% (explicit forecast period until FY17F, second-stage growth forecast until FY20). We believe that using 4% terminal growth is justified since rising competition and demand saturation will put a check on high growth rates. Our 4% terminal growth assumption is also in line with the estimated ~4% revenue CAGR over FY15-17F.
Risks
What could trigger upside in the stock? A higher-than-expected share of private orders under the 12th and 13th Five-year Plans; Delays or cancellation in capacity by new domestic equipment manufacturers; Substantial decline in key commodity prices such as steel and copper, as almost half of the order book is on fixed price contract, in our view. What could trigger downside in the stock? Worsening of fuel availability for new and/or already ordered projects could lead to delays in new and existing orders. Rising competition could drive pricing even lower than our current estimates, thus pressurising margins.
20
Crompton Greaves
INDUSTRIALS
CROM.NS CRG IN .
EQUITY RESEARCH
Fundamentals do not change due to adverse cycle
October 12, 2011 Rating Remains Target price Remains Closing price October 7, 2011 Potential upside
Opportunity remains lucrative, though worsening global macro causes near-term pains
Impression: Significant macro risk already priced in; Buy In a sector with growing competitive intensity, we believe players with low cost structures will benefit. CRGs 34% market share of PGCILs transformer orders over FY09-11, along with double-digit margins over the same period, testify to its low-cost advantage, in our view. Even though the business outlook has deteriorated, we believe this reflects a cyclical trough and is not company-specific. And although the timing of recovery in the India and international markets is uncertain, we think the structural opportunity is attractive. Our evaluation:
Buy
INR 240 INR 149 +61.1%
Anchor themes Decades of under-investment, followed by a march towards building sufficient power for the nation create significant opportunities, though structural constraints and rising competition suggest the need to be selective. Nomura vs consensus Our FY13F EPS is 17% higher than consensus as we build in a tax shelter from increased R&D spend, which we believe consensus has yet to factor in.
FY11 margin levels are close to the peak of the cycle and suggest
downside risks, but we believe these are largely built into consensus estimates.
Sales are cyclical but have also been impacted by a slow pick-up in
domestic power orders. Risk from global slowdown is a key overhang.
In contrast, consensus estimates have adjusted sharply since peak

levels, and mostly have changed to reflect post-1QFY12 results. Valuation: At 9.6x FY13F EPS, stock factors in significant EPS risk While the stock is already trading below its 10-year mean multiples now, we note that CRG has undergone significant transformation over the past 5-6 years (following acquisitions as well as rising market share and margins in domestic markets). We also highlight that since this transformation, CRG is now trading at some of the lowest multiples since FY05 even on significantly reduced earnings estimates. We maintain our estimates and TP, implying 61% upside potential from current levels. Buy.
100,051 110,459 110,459 125,990 125,990 147,523 147,523 9,268 9,268 14.45 12.4 10.7 7.5 3.0 1.7 32.1 5.2 7,830 7,830 12.21 -15.5 N/A 9.0 N/A N/A 21.8 3.3 7,830 7,830 12.21 -15.5 12.7 9.0 2.5 1.6 21.8 10,302 10,302 16.06 31.6 N/A 7.0 N/A N/A 23.9 10,302 10,302 16.06 31.6 9.6 7.0 2.1 2.1 23.9 12,578 12,578 19.61 22.1 N/A 5.5 N/A N/A 24.0 12,578 12,578 19.61 22.1 7.9 5.5 1.7 2.5 24.0
3.3 net cash net cash net cash net cash
Nomura | Crompton Greaves
October 12, 2011
Key data on Crompton Greaves


FY10 91,409 -59,517 31,892 -9,542 -11,131 11,219 12,770 -1,551 11,219 -428 32 1,100 11,922 -3,650 8,272 -26 FY11 100,051 -66,916 33,135 -9,822 -11,811 11,502 13,438 -1,936 11,502 -352 80 1,142 12,372 -3,100 9,272 -4 FY12F 110,459 -77,553 32,906 -11,001 -13,229 8,677 11,118 -2,441 8,677 -376 80 1,155 9,536 -1,702 7,834 -4 FY13F 125,990 -87,561 38,430 -12,321 -14,816 11,293 13,810 -2,517 11,293 -376 80 1,258 12,255 -1,948 10,307 -4 FY14F 147,523 -102,844 44,679 -13,799 -17,039 13,841 16,664 -2,823 13,841 -376 80 1,419 14,964 -2,381 12,583 -5
(INR) 350 300 250 80 200 150 100 A ug 11 S ep 11 N ov 10 M ay 11 F eb 11 J an 11 D ec 10 M ar 11 J un 11 O c t 11 A pr 11 J ul 11 60 40 Price Rel MSCI India 120 100
Source: ThomsonReuters, Nomura research

(%) Absolute (INR) Absolute (USD) Relative to index Market cap (USDmn) Estimated free float (%) 52-week range (INR) 3-mth avg daily turnover (USDmn) Major shareholders (%) Avantha Holdings Solaris Holding 1M 3M 12M
13.1 -40.0 -51.4 6.4 -44.9 -55.5 7.7 -29.4 -32.1 2,025.6 54.9 349/132.75 18.88
8,247 8,247 -947 7,299
9,268 9,268 -1,645 7,623
7,830 7,830 -1,551 6,279
10,302 10,302 -2,045 8,257
12,578 12,578 -2,501 10,077
39.1 25.4
12.1 18.7 12.1 1.0 10.5 4.0 7.6 8.7 34.9 14.0 12.3 9.0 30.6 11.5 1.7 1.0 38.0 21.4
10.7 16.6 10.7 1.7 18.4 3.0 7.5 8.7 33.1 13.4 11.5 9.3 25.1 17.7 7.6 3.9 32.1 18.9
12.7 19.7 12.7 1.6 10.6 2.5 9.0 11.5 29.8 10.1 7.9 7.1 17.8 19.8 7.7 3.5 21.8 11.8
9.6 14.9 9.6 2.1 9.7 2.1 7.0 8.6 30.5 11.0 9.0 8.2 15.9 19.9 4.8 2.4 23.9 13.4
7.9 12.2 7.9 2.5 8.0 1.7 5.5 6.6 30.3 11.3 9.4 8.5 15.9 19.9 4.1 2.1 24.0 14.5
Notes
Effective tax rate declining over FY12-14F
4.6 28.3 28.4 47.3 47.3
9.5 5.2 2.5 12.4 12.4
10.4 -17.3 -24.6 -15.5 -15.5
14.1 24.2 30.1 31.6 31.6
17.1 20.7 22.6 22.1 22.1
12.85 12.85 12.85 39.04 1.48
14.45 14.45 14.45 51.05 2.56
12.21 12.21 12.21 60.83 2.42
16.06 16.06 16.06 73.70 3.19
19.61 19.61 19.61 89.41 3.90
22
October 12, 2011
Cashflow(INRmn)
FY10 12,770 -125 -3,207 9,437 -1,526 7,911 -3,864 FY11 13,438 -4,459 -3,588 5,391 -7,593 -2,202 -1,211 FY12F 11,118 269 -2,002 9,384 -8,550 834 0 FY13F 13,810 -1,346 -2,248 10,216 -6,000 4,216 0 FY14F 16,664 -1,537 -2,683 12,445 -6,000 6,445 0 Notes
Sufficient free cashflow to fund current quantum of capex and acquisitions
1,100 5,148 -947 -2,173 0 -996 -4,116 1,032 5,656 6,688 -1,679
1,142 -2,271 -1,645 -306 0 518 -1,433 -3,704 6,688 2,984 1,719
1,155 1,989 -1,551 0 0 0 -1,551 439 2,984 3,423 1,280
1,258 5,474 -2,045 0 0 0 -2,045 3,428 3,423 6,851 -2,148
1,419 7,864 -2,501 0 0 0 -2,501 5,364 6,851 12,215 -7,512
Balancesheet(INRmn)
FY10 6,688 21,463 10,194 2,674 41,018 5,536 13,760
FY11 2,984 25,427 11,893 5,192 45,496 6,747 19,417
FY12F 3,423 27,842 13,747 5,716 50,728 6,747 25,526
FY13F 6,851 31,756 15,565 6,520 60,692 6,747 29,009
FY14F 12,215 37,184 18,306 7,634 75,338 6,747 32,186
Notes
Working capital cycle is lengthening and needs to be tracked, although it is not a major concern as yet
0 60,314 26,567 3,603 30,170 5,010 49 35,229 43 0 1,283 23,760
0 71,660 29,595 4,298 33,892 4,703 160 38,756 157 0 1,283 31,464
0 83,001 34,209 4,745 38,954 4,703 160 43,817 157 0 1,283 37,743
0 96,448 38,732 5,412 44,144 4,703 160 49,008 157 0 1,283 46,000
0 114,271 45,554 6,337 51,891 4,703 160 56,754 157 0 1,283 56,077
25,043 60,314
32,747 71,660
39,026 83,001
47,283 96,448
57,360 114,271
1.36 26.2
1.34 32.7
1.30 23.1
1.37 30.0
1.45 36.8
net cash net cash
0.13 5.2
0.12 3.3
net cash net cash
net cash net cash
83.9 64.8 161.3 -12.5
85.5 60.2 153.2 -7.4
88.3 60.5 150.6 -1.8
86.3 61.1 152.0 -4.6
85.3 60.1 149.6 -4.2
23
October 12, 2011
How well is Crompton Greaves positioned for a turn in the cycle?

We have used consolidated numbers to chart the historical financials for Crompton Greaves (CRG), as subsidiaries form a substantial part of the business and valuation for the company. Since the major impact of the company's international acquisitions started to be felt only from FY06, we have, at times, restricted our reference period to that timeline for relevance purposes.

Consistency of return ratios Return ratios for CRG have been healthy at above 30% since its acquisition of international businesses, starting from FY06. We do notice some volatility around a change in cycles, which we believe is largely led by sales slowdown and some working capital pressure.
Fig. 26: Return ratios have been stable since FY06
45% 40% 35% 30% 25% 20% 15% 10% 5% 0%
FY02 FY03 FY04 FY05 FY06 FY07 FY08 FY09 FY10 FY11
Fig. 27: with some volatility around business cycles

ROCE
ROE
48% 43% 38% 33% 28% 23% 18% 13% 8%
FY02
FY03
FY04
FY05
FY06
FY07
FY08
FY09
FY10
Management of working capital and asset turnover We believe the company has maintained tight control over its working capital cycle, which is evident in the charts below. The increase in the WC cycle in FY11 is mainly due to adverse business cycles, in our view. Despite slower sales, asset turnover has remained steady, mainly due to tight control over capital employed in both fixed assets and working capital, on our reading.
FY11
24
October 12, 2011
Fig. 28: Asset t/o depicting pressure from slower sales

(x) 1.6 1.5 1.4 1.3 1.2 1.1 1.0 Asset turnover
Fig. 29: and recent uptick in WC cycle; cyclical nature

(x) 1.9 1.8 1.7 1.6 1.5 1.4 1.3 1.2 1.1 1.0 Asset turnover (ex cash)
FY02
FY03
FY04
FY05
FY06
FY07
FY08
FY09
FY10
FY11
FY02
FY03
FY04
FY05
FY06
FY07
FY08
FY09
FY10
Fig. 30: Sharp improvement in WC cycle, barring past 12m, led by a decline in receivables and inventory days
Days of revenue
60 55 50 45 40 35 30 25 20 15 10
FY02 FY03 FY04
FY05
FY06
FY07
FY08
FY09
FY10
Trajectory of growth The companys sales trend has been disappointing over the past few years, although margins have been rising. We largely attribute this to tight control over costs and the benefit from operating leverage. However, given concerns over sales growth in the near term owing to a slowing global economy, we believe margins could suffer (as evident in the 1QFY12 results) in the near term.
FY11
FY11
25
October 12, 2011
Fig. 31: Sales have been under pressure and is a key risk
Fig. 32: Margins close to all-time peak; we see downside risks

% of revenues
120% 100% 80% 60% 40% 20% 0% -20%
Sales growth
15% 14% 13% 12% 11% 10% 9% 8% 7%
EBITDA margin
FY02
FY03
FY04
FY05
FY06
FY07
FY08
FY09
FY10
FY02
FY03
FY04
FY05
FY06
FY07
FY08
FY09
FY10
FY11
Risks from an adverse turn in the cycle

While sales already indicate a bottom-cycle trend, margins are close to peak cycle. Risk to sales Post the Lehman crisis, overall sales had nearly approached zero growth, but refrained from entering negative territory. This, in our view, was led mainly by a slowdown in international markets. We continue to see similar risks to sales owing to ongoing concerns about global economies, especially in the the US and Europe. Risk to margins FY11 margin levels are at close to the top-end of the margin range (9-14%), and we see downside risks from these levels. Average historical margins for the company (since FY06) have been at around 11.5%, though post the Lehman crisis, margins were still rising. Depending on the extent of slowdown in global economies, we could see 300400bp margin risk for the company. Our FY12F estimates factor in 330bps.

Mean consensus EPS estimates have corrected 30-35% for CRG since peaking, with recent estimates falling even lower. We believe current consensus estimates already build in risks to margins for the company, though there is still some risk to sales from a severe global slowdown.
FY11
26
October 12, 2011
Fig. 33: Consensus earnings estimates already down 30-35% since peak
(INR) 21 19 17 15 13 11 9 Consensus EPS FY12 Consensus EPS FY13
Oct-10
Oct-09
Apr-09
Apr-10
Apr-11
Aug-10
Aug-09
Source: Bloomberg
What are valuations factoring in?

CRG has largely traded at 15-25x earnings since FY06 (post acquisitions) except during the post-Lehman bankruptcy period. Even on a longer timeframe of 10 years, we note that the stock is now trading below the mean trading levels both on a P/E and P/BV basis. While a severe recession in Europe and the US could lead to further interim de-rating of the stock, we believe it is now pricing in visible medium-term risks to margins and sales growth.
Fig. 34: Stock is trading below 10-year mean trading multiples
Crompton Greaves 1-year fwd P/E chart
Fig. 35: and even lower on average levels since FY06

Crompton Greaves 1-year fwd P/BV chart
Aug-11
1 yr fwd P/B chart +1STDEV Mean -1STDEV
Dec-09
Dec-10
Jun-09
Jun-10
Feb-09
(x) 35 30 25 20 15 10 5 0
Feb-10
(x) 10 9 8 7 6 5 4 3 2 1 0
Feb-11
Mar-00
Mar-01
Jun-11
Mar-02
Mar-03
Mar-04
Mar-05
Mar-06
Mar-07
Mar-08
Mar-09
Mar-10
Mar-01
Mar-02
Mar-03
Mar-04
Mar-05
Mar-06
Mar-07
Mar-08
Mar-09
Mar-10
Mar-11
Impression: Significant macro risk already priced-in, though extreme case could see further interim risks
CRG stock has corrected by more than 55% over the past 12 months and has underperformed the broader markets by 22%. At current levels, we believe the stock is attractively valued and significant earnings risk is already priced in. However, we do not rule out further correction in the interim were global macro conditions take a sharper dip. On a longer-term horizon, we believe CRG presents an attractive risk-reward opportunity. Our evaluation is based on:
Mar-11
27
October 12, 2011
Despite FY11 margin levels being close to the peak of the cycle and have downside risks, we believe these are largely built into consensus estimates. Sales growth is cyclical but has also been impacted by a slow pick-up in domestic power orders. Risk from a severe global slowdown will be a key overhang. In contrast, consensus estimates have adjusted sharply since peak levels, and mostly have changed to reflect post-1QFY12 results. The stock is now trading below 10-year mean multiples, but since the company has transformed significantly over the past 5-6 years (on the back of international acquisitions as well as rising market share and margins in domestic markets), we would place more emphasis on a mean trading range comparison with the likes of MNC peers such as ABB, SIEM and Areva T&D, which are trading above 16x 1 year forward EPS. Since these acquisitions, the stock is now trading significantly below mean levels and on lowered earnings estimates nonetheless.
Valuation methodology
We continue to value the core business at 15x Mar-13F EPS of INR16.06 to arrive at our TP of INR240. Our multiple of 15x is at a slight discount to the mid-cycle multiple of 16x for the stock, which we believe is justified, given that we believe business conditions are reflective of cyclical pains at this point.
Investment risks
1) Further slowdown in power sector investments; 2) rising competition in domestic and international T&D; 3) worsening of the European crisis, and; 4) a substantial rise in commodity prices could hit margins.
28
Cummins India
CUMM.NS KKC IN .
EQUITY RESEARCH
For the long term
October 12, 2011 Rating Remains Target price Remains Closing price October 7, 2011 Potential upside
Near-term concerns on a worsening macro, but wait for opportunity

Impression: Near-term risks from global slowdown, but impressive fundamentals imply share price strength upon correction Despite more than a 30% correction since its past 12-month peak, we do not rule out near-term downside risks for Cummins India, in case of a severe global recession. Our evaluation is based on:
Neutral
INR 430 INR 406 +5.9%
FY11 margin levels are at the peak of the cycle and could be prone to
downside risks, but this could be partially offset by lower RM costs.
Anchor themes We believe Indias industrial sector offers the unfolding of a substantial opportunity over the coming years. We see potential opportunities in niche segments. Nomura vs consensus We are in line with consensus on FY13F earnings but our TP is 10% lower on greater caution towards the exports outlook for the company.
Sales growth is cyclical and tends to be highly volatile around turns. In comparison, consensus estimates have corrected only modestly. Current valuations do not appear appealing, compared with the
historical mean on both a P/E and P/BV basis. However, we would review our estimates upon a market correction. Cutting estimates on near-term slowdown risks; maintain Neutral We are cutting our FY12-14F estimates by 10-15% to account for slower sales growth (mainly exports) on account of an anticipated global slowdown. We also lower our margin estimates modestly on account of falling utilisation levels, albeit slightly offset by a fall in raw material costs. Despite the near-term risk on earnings growth, we continue to see Cummins India as a fundamentally strong company which has managed its balance sheet and return ratios well in past cycles. Our valuation methodology remains unchanged (except for rolling over to Sep-13F EPS from Mar-13F earlier) as we value the stock at 15x Sep-13F EPS of INR28.6 to arrive at our TP of INR430, which is in line with the stocks mid-cycle trading range.
39,105 5,910 5,789 20.88 32.4 19.5 16.2 6.2 3.1 35.1
45,278 7,026 6,615 23.86 14.3 N/A 13.4 N/A N/A 36.0
44,897 6,918 6,507 23.47 12.4 17.3 13.7 5.4 3.6 35.5
54,400 7,958 7,958 28.71 20.3 N/A 11.1 N/A N/A 35.1
50,467 7,113 7,113 25.66 9.3 15.8 12.5 4.7 3.7 31.7
62,898 9,115 9,115 32.88 14.5 N/A 9.5 N/A N/A 34.8
61,500 8,725 8,725 31.47 22.7 12.9 10.0 4.1 4.5 33.9
net cash net cash net cash net cash net cash net cash net cash
Nomura | Cummins India
October 12, 2011
Key data on Cummins India


FY10 28,125 -18,383 9,741 -2,877 -1,953 4,912 5,273 -361 4,912 -21 419 799 6,109 -1,736 4,373 FY11 39,105 -26,170 12,935 -4,120 -2,546 6,268 6,635 -366 6,268 -19 262 1,512 8,024 -2,235 5,789 FY12F 44,897 -29,977 14,920 -4,753 -3,056 7,111 7,547 -436 7,111 -19 513 1,369 8,974 -2,468 6,507 FY13F 50,467 -33,780 16,687 -5,091 -3,667 7,929 8,520 -590 7,929 -19 410 1,491 9,811 -2,698 7,113 FY14F 61,500 -41,166 20,334 -6,204 -4,217 9,914 10,634 -720 9,914 -19 404 1,735 12,034 -3,309 8,725
(INR) 600 550 500 105 450 400 350 A ug 11 S ep 11 N ov 10 M ay 11 F eb 11 J an 11 D ec 10 M ar 11 J un 11 O c t 11 A pr 11 J ul 11 100 95 Price Rel MSCI India 115 110

(%) Absolute (INR) Absolute (USD) Relative to index Market cap (USDmn) Estimated free float (%) 52-week range (INR) 3-mth avg daily turnover (USDmn) Major shareholders (%) Cummins Inc LIC 1M 3M 12M
-7.4 -16.5 -22.1 -12.3 -24.7 -29.6 -4.2 2,291.3 49.0 578.57/395 3.01 -2.6 -0.3
4,373 65 4,439 -2,775 1,663
5,789 121 5,910 -3,457 2,453
6,507 412 6,918 -4,026 2,892
7,113 0 7,113 -4,140 2,973
8,725 0 8,725 -5,078 3,647
51.0 8.2
25.8 27.3 25.4 2.5 16.0 7.2 19.7 21.0 34.6 18.7 17.5 15.8 28.4 62.5 2.2 1.7 30.0 24.0
19.5 20.6 19.1 3.1 21.6 6.2 16.2 17.1 33.1 17.0 16.0 15.1 27.9 58.5 3.7 3.9 35.1 25.8
17.3 18.3 16.3 3.6 12.0 5.4 13.7 14.4 33.2 16.8 15.8 15.4 27.5 58.2 7.8 8.0 35.5 25.9
15.8 16.8 15.8 3.7 17.8 4.7 12.5 13.4 33.1 16.9 15.7 14.1 27.5 58.2 6.9 5.9 31.7 24.4
12.9 13.7 12.9 4.5 13.7 4.1 10.0 10.7 33.1 17.3 16.1 14.2 27.5 58.2 3.3 2.8 33.9 26.0
Notes
Slowing revenue growth to mirror macro concerns in the domestic and international markets
-14.1 10.5 13.8 4.8 4.8
39.0 25.8 27.6 32.4 32.4
14.8 13.8 13.5 12.4 12.4
12.4 12.9 11.5 9.3 9.3
21.9 24.8 25.0 22.7 22.7
16.01 15.78 15.78 56.31 10.01
21.32 20.88 20.88 65.16 12.47
24.96 23.47 23.47 75.59 14.53
25.66 25.66 25.66 86.32 14.93
31.47 31.47 31.47 99.47 18.32
30
October 12, 2011
Cashflow(INRmn)
FY10 5,273 2,238 -473 7,037 -607 6,430 -3,337 61 0 0 3,154 -2,775 0 -143 FY11 6,635 -1,054 -358 5,222 -1,440 3,782 75 -18 0 11 3,850 -3,457 0 96 FY12F 7,547 1,995 -193 9,349 -3,500 5,849 -158 0 0 0 5,692 -4,026 0 -183 FY13F 8,520 -1,392 -816 6,312 -3,500 2,812 0 0 0 0 2,812 -4,140 0 0 FY14F 10,634 -1,198 -1,189 8,247 -2,000 6,247 0 0 0 0 6,247 -5,078 0 0 Notes
Despite adversities, cash flow generation remains strong
-2,918 236 323 559 -473
-3,361 489 559 1,049 -855
-4,209 1,483 1,037 2,520 -2,520
-4,140 -1,328 2,520 1,192 -1,192
-5,078 1,169 1,192 2,361 -2,361
Balancesheet(INRmn)
FY10 559 7,056 5,229 4,097 2,788 19,728 274 3,337
FY11 1,037 6,981 7,182 5,190 3,396 23,785 274 4,411
FY12F 2,520 7,139 7,380 5,442 3,420 25,900 274 7,475
FY13F 1,192 7,139 8,987 6,114 3,832 27,263 274 10,385
FY14F 2,361 7,139 10,952 7,451 4,648 32,550 274 11,665
Notes
Clean and strong balance sheet, though limited visibility on any inorganic growth intent
170 23,508 86 5,178 2,634 7,898
187 28,657 183 7,109 3,302 10,594
187 33,836 0 7,165 5,717 12,882
187 38,109 0 8,098 6,083 14,181
187 44,676 0 9,710 7,391 17,101
0 7,898 0 554 15,056
0 10,594 0 554 17,508
0 12,882 0 554 20,400
0 14,181 0 554 23,373
0 17,101 0 554 27,020
15,610 23,508
18,063 28,657
20,954 33,836
23,928 38,109
27,574 44,676
2.50 239.5
2.25 330.2
2.01 374.6
1.92 417.7
1.90 522.3
net cash net cash
net cash net cash
net cash net cash
net cash net cash
net cash net cash
78.2 87.1 110.7 54.6
57.9 64.8 85.7 37.0
59.4 64.9 87.1 37.1
59.2 62.4 82.5 39.2
59.2 60.1 78.9 40.4
31
October 12, 2011
How well is Cummins India positioned for a turn in the cycle?

Consistency of return ratios Despite interim cyclicality, Cummins India has been able to maintain a healthy and consistently rising ROE/ROCE trend.
Fig. 36: KKC: ROE has consistently been on a rising trend
ROE
Fig. 37: and so has its ROCE

55% 50% 45% 40% 35% 30% 25% 20% 15% ROCE
40% 35% 30% 25% 20% 15% 10%
FY99
FY00
FY01
FY02
FY03
FY04
FY05
FY06
FY07
FY08
FY09
FY10
FY11
FY99
FY00
FY01
FY02
FY03
FY04
FY05
FY06
FY07
FY08
FY09
FY10 FY10
Management of working capital and asset turnover A steady trend of declining net working capital cycle and rising asset turnover implies strong management quality for the company over the past 12 years, in our view.
Fig. 38: Asset turnover too has been on a rise, though rising cash levels and slowing exports hit FY10 and FY11
(x) 1.6 1.5 1.4 1.3 1.2 1.1 1.0 0.9
FY99 FY00 FY01 FY02 FY03 FY04 FY05 FY06 FY07 FY08 FY09 FY10 FY11
Fig. 39: Asset turnover ex cash confirms a secular uptrend in the business
(x) 2.0 1.9 1.8 1.7 1.6 1.5 1.4 1.3 1.2 1.1
FY99 FY00 FY01 FY02 FY03
Asset turnover
Asset turnover (ex cash)
FY04
FY05
FY06
FY07
FY08
FY09
FY11
32
FY11
October 12, 2011
Fig. 40: Management efforts, depicted in a tight rein over Net WC cycle (ex cash), partly explains rising ROCE
Days of revenue
160 140 120 100 80 60 40 20 0
FY99
FY00
FY01
FY02
FY03
FY04
FY05
FY06
FY07
FY08
FY09
FY10
Trajectory of growth Cummins sales have been largely dependent on business cycles and depict great volatility around trend shift. Margins also depict similar business cyclicality, although we notice that the lows are now shallower.
Fig. 41: Sales growth trend in line with business cycles; highly volatile around change in momentum
Sales growth
Fig. 42: Margins trend suggest cyclical business nature strong sense of dj vu in FY10-11; see downside risks
% of revenues
FY11
50% 40% 30% 20% 10% 0% -10% -20%
20% 19% 18% 17% 16% 15% 14% 13% 12% 11% 10%
EBITDA margin
FY99
FY00
FY01
FY02
FY03
FY04
FY05
FY06
FY07
FY08
FY09
FY10
FY99
FY00
FY01
FY02
FY03
FY04
FY05
FY06
FY07
FY08
FY09
FY10
FY11

Sales and margin trends suggest that the business is close to peak cycle levels. Risk to sales Post the 2008-09 global financial crisis, overall sales declined by more than 10% in FY10, from very high growth rates until then. In an extreme global economic slowdown, we foresee that a similar (or even greater) decline is indeed possible for Cummins. Risk to margins FY11 margin levels are at the top-end of the margin range (11-19%) and we clearly notice downside risks from these levels. Average historical margins for the company have been around 14%, and incidentally the bottom during the 2008-09 global financial crisis period was also 14%. Therefore, the risk from the FY11 levels is around 300bps, on our estimates.
FY11
33
October 12, 2011

Consensus EPS estimates have corrected by ~20% for Cummins India since their peak. However, given the risk to sales and margins as highlighted above, we believe further downside risks are possible.
Fig. 43: Consensus estimates down 20% from peak; we see further downside risks
(INR) 40 35 30 25 20 15 Consensus EPS FY12 Consensus EPS FY13
Nov-10
Jun-10
Jun-10
Jan-11
Jun-11
Jul-10
Jul-11
May-11
May-11
Mar-11
Mar-11
Feb-11
Aug-10
Aug-10
Sep-10
Dec-10
Dec-10
Apr-11
Oct-10
Oct-10
Jul-11
Aug-11
Source: Bloomberg
What is valuation factoring in?

Cummins India largely traded at 10-15x P/E during FY01 to FY07 when growth was much lower than the post-FY07 period and margins were also lower than the current mean. However, we rule out similar low multiples as the FY01-07 range for Cummins, because of continuous improvement in its balance sheet through tighter WC cycle management and asset efficiency. Cummins Indias trailing 12-year mean P/E multiple is 15x, while the stock is currently trading at ~16x 1-year forward earnings which is close to the mean. On a P/BV basis, the stock is still +0.5 STDEV of mean levels.
Sep-11
34
October 12, 2011
Fig. 44: KKC trading close to 12-year mean P/E multiple

KKC 1 year fwd P/E chart
Fig. 45: while slightly higher than mean P/B multiple

KKC 1 year fwd P/B chart
(x) 30 25 20 15 10 5
(x) 9 8 7 6 5 4 3 2 1 0
Mar-00
Mar-01
Mar-02
Mar-03
Mar-04
Mar-05
Mar-06
Mar-07
Mar-08
Mar-09
Mar-10
Mar-00
Mar-01
Mar-02
Mar-03
Mar-04
Mar-05
Mar-06
Mar-07
Mar-08
Mar-09
Mar-10
Mar-11
Impression: Near-term risks from slowdown, but impressive fundamentals imply future strength
Although Cummins India stock has corrected by over 30% since its past 12-month peak, we do not rule out any near-term downside risks for Cummins India in case of a severe global recession. Our evaluation is based on: FY11 margin levels are at the peak of the cycle and could be prone to downside risks, though we note that falling commodity prices would compensate for margin loss due to lower utilisation. Sales growth is cyclical and tends to be highly volatile around a change in momentum. In comparison, consensus estimates have corrected only modestly. Current valuations do not appear appealing, compared with the historical mean on both a P/E and P/BV basis. However, we would review our estimates upon a market correction. We are positive on the company in the longer term.
Cutting estimates on near-term slowdown risks; remain Neutral on strong fundamentals

We are cutting our FY12-14F estimates by 10-15% to account for slower sales growth (mainly in exports) on account of an anticipated global slowdown. We are also lowering our margin estimates modestly on account of falling utilisation levels, though slightly offset by a fall in RM cost. Despite near-term risks on earnings growth, we continue to see Cummins India as a fundamentally strong company which has managed its balance sheet and return ratios well in past cycles. Our valuation methodology remains unchanged (except for rolling over to Sep-13F EPS from Mar-13F earlier) as we value the stock at 15x Sep-13F EPS of INR28.6 to arrive at our target price of INR430, which is in line with the stocks mid-cycle trading range.
Risks to our call

Downside risks: appreciation of the rupee, diesel prices pose a risk to demand for backup power; competition from Chinese players. Upside risks: raw material cost could pose negative or positive upsides depending on commodity price movements; export recovery could continue to surprise in the near term.
Mar-11
35
Voltas
VOLT.NS VOLT IN .
ENGINEERING & CONSTRUCTION
EQUITY RESEARCH
Strong leverage to adverse macro priced in now
October 12, 2011 Rating Remains Target price Reduced from 234 Closing price October 7, 2011 Potential upside
Retain Buy on attractive longterm opportunity; concerns priced in

Action: Assuming coverage; attractive opportunity, although business is highly correlated to global macro conditions; Buy Voltas has underperformed the SENSEX by 35% over the past 12 months on a slowdown in sales and margin concerns. We see limited further nearterm downside risk from current levels even in a bear-case scenario, although the extreme case could drive further downside. Long term, however, we believe the stock is attractively valued and would use any correction to accumulate. FY11 margin levels are close to peak levels; we see a 100-150bp downside correction risk from here. Adverse macro conditions are likely to hurt near-term order inflows and sales growth; any pickup is contingent on global macro trends. Consensus estimates are largely building in margin risk, although some risk could emerge from a further sales slowdown. With consensus estimates also largely capturing earnings risk and valuations factoring in an even greater earnings decline, we believe current levels offer a good entry point from a long-term perspective.
Buy
INR 150 INR 105 +42.9%
Anchor themes Investment cycle in India has been disappointing on various external and internal issues. While we remain constructive from a long-term perspective, worsening macro conditions could drive further risks before things improve. Voltas is a key beneficiary of infrastructure capex in India & Middle East. Nomura vs consensus Our FY12F EPS forecast is 20% lower than consensus on lower margin expectations in EMP segment.
Research analysts India Capital Goods Amar Kedia - NFASL amar.kedia@nomura.com +91 22 4037 4182 Lalit Kumar - NFASL lalit.kumar@nomura.com +91 22 4037 4511 Indrajit Yadav - NSFSPL indrajit.yadav@nomura.com +91 22 4037 4992 New
Cutting estimates ~30% and TP to INR150 to factor in adverse macro We cut our FY12-13F earnings on increased concerns over the companys near-term sales and margin outlook in the electro-mechanical and unitary cooling product segments, following a transfer of analyst coverage. Our revised TP of INR150 is based on 14x (previously: 16.3x) Sep-13F EPS of INR10.85, suggesting 43% implied upside. We assume coverage of the stock with a Buy rating.
31 Mar Currency (INR) FY11 Actual Old FY12F New Old FY13F New Old FY14F
51,914 3,572 3,171 9.58 -10.9 10.9 6.8 2.5 2.2 29.2
59,253 3,737 3,737 11.28 17.7 N/A 5.1 N/A N/A 24.6
51,643 3,241 2,696 8.14 -15.1 12.9 7.2 2.1 1.9 21.7
70,792 4,622 4,622 13.96 23.7 N/A 3.8 N/A N/A 24.9
56,027 3,222 3,222 9.73 19.5 10.8 5.9 1.8 1.9 18.4 N/A N/A N/A
63,540 3,964 3,964 11.97 23.0 8.8 4.3 1.6 2.3 19.5 net cash
Nomura | Voltas
October 12, 2011
Key data on Voltas


FY10 48,236 -33,206 15,030 -10,475 0 4,555 4,769 -214 0 4,555 -98 0 612 5,068 -1,472 3,595 -36 FY11 51,914 -37,018 14,896 -10,552 0 4,344 4,554 -210 0 4,344 -165 0 664 4,843 -1,729 3,114 57 FY12F 51,643 -37,037 14,606 -11,062 0 3,544 3,969 -425 0 3,544 -347 -1 803 4,000 -1,273 2,726 -31 FY13F 56,027 -40,182 15,845 -11,800 0 4,044 4,503 -458 0 4,044 -274 0 1,091 4,862 -1,604 3,257 -36 FY14F 63,540 -45,568 17,972 -12,940 0 5,032 5,523 -492 0 5,032 -154 0 1,091 5,969 -1,970 3,999 -36
(INR) 300 250 200 150 100 A ug 11 S ep 11 N ov 10 M ay 11 F eb 11 J an 11 D ec 10 M ar 11 J un 11 O c t 11 A pr 11 J ul 11 Price Rel MSCI India 120 100 80 60 40

(%) Absolute (INR) Absolute (USD) Relative to index Market cap (USDmn) Estimated free float (%) 52-week range (INR) 3-mth avg daily turnover (USDmn) Major shareholders (%) Tata Group of Companies LIC, India 1M 3M 12M
-14.3 -36.6 -56.2 -18.9 -42.8 -60.4 -11.2 -22.6 -34.4 705.0 0.6 262.5/102 3.49
3,560 250 3,810 -615 3,195
3,171 402 3,572 -768 2,805
2,696 546 3,241 -655 2,587
3,222 0 3,222 -651 2,570
3,964 0 3,964 -800 3,164
27.7 12.9
9.7 13.9 9.1 1.8 11.3 3.2 6.4 6.7 31.2 9.9 9.4 7.9 29.1 16.1 0.7 1.5 40.6 16.0
10.9 15.6 9.7 2.2 88.4 2.5 6.8 7.2 28.7 8.8 8.4 6.9 35.7 21.5 0.9 2.1 29.2 13.2
12.9 18.4 10.7 1.9 10.6 2.1 7.2 8.0 28.3 7.7 6.9 6.3 31.8 20.2 1.0 1.2 21.7 9.7
10.8 15.4 10.8 1.9 13.9 1.8 5.9 6.5 28.3 8.0 7.2 5.8 33.0 20.2 0.9 1.1 18.4 10.8
8.8 12.5 8.8 2.3 12.1 1.6 4.3 4.8 28.3 8.7 7.9 6.2 33.0 20.2 0.8 1.0 19.5 12.3
Notes
Adverse macro situation drives near-term revenue slowdown
10.6 49.5 52.9 57.9 58.1
7.6 -4.5 -4.6 -10.9 -10.9
-0.5 -12.8 -18.4 -15.1 -15.1
8.5 13.4 14.1 19.5 19.5
13.4 22.7 24.4 23.0 23.0
11.51 10.75 10.75 32.78 1.86
10.80 9.58 9.58 41.17 2.32
9.79 8.14 8.14 48.93 1.98
9.73 9.73 9.73 56.69 1.97
11.97 11.97 11.97 66.23 2.41
37
Nomura | Voltas
October 12, 2011
Cashflow(INRmn)
FY10 4,769 -526 -1,177 3,065 -317 2,748 -775 -236 350 0 208 2,295 -615 0 -1,463 0 -99 -2,177 119 4,571 4,689 -4,337 FY11 4,554 -3,524 -638 392 -446 -54 -271 -244 442 0 321 195 -768 0 1,030 0 -166 96 291 4,689 4,980 -3,599 FY12F 3,969 32 -728 3,273 -500 2,773 0 -31 0 0 801 3,543 -655 0 1,350 0 -347 349 3,892 4,980 8,872 -6,142 FY13F 4,503 -404 -1,604 2,495 -500 1,995 0 -36 0 0 1,091 3,050 -651 0 -900 0 -274 -1,825 1,225 8,872 10,097 -8,267 FY14F 5,523 -697 -1,970 2,857 -500 2,357 0 -36 0 0 1,091 3,412 -800 0 -1,100 0 -154 -2,053 1,359 10,097 11,456 -10,726 Notes
FCF generation remains good despite adverse macro
Balancesheet(INRmn)
FY10 4,689 2,030 10,060 11,441 2,078 30,297 309 2,262 764 0 204 33,837 45 11,142 8,706 19,893 306 0 2,647 22,846 139 0 331 10,521 0 0 10,852 33,837
FY11 4,980 2,192 11,705 16,185 2,440 37,501 421 2,458 916 0 170 41,466 101 13,383 9,692 23,177 1,280 0 3,175 27,631 218 0 331 13,286 0 0 13,617 41,466
FY12F 8,872 2,192 11,636 16,099 2,440 41,239 421 2,533 916 0 170 45,279 1,450 13,312 9,640 24,402 1,280 0 3,175 28,857 218 0 331 15,873 0 0 16,204 45,279
FY13F 10,097 2,192 12,622 17,467 2,440 44,818 421 2,575 916 0 170 48,900 850 14,444 10,460 25,753 980 0 3,175 29,908 218 0 331 18,444 0 0 18,774 48,900
FY14F 11,456 2,192 14,321 19,821 2,440 50,230 421 2,583 916 0 170 54,320 50 16,390 11,869 28,309 680 0 3,175 32,164 218 0 331 21,607 0 21,938 54,320
Notes
Pressure on working capital is rising though we expect this to be well contained
1.52 46.3
1.62 26.3
1.69 10.2
1.74 14.8
1.77 32.8
net cash net cash
net cash net cash
net cash net cash
net cash net cash
net cash net cash
74.1 124.4 126.0 72.5
76.5 136.2 120.9 91.8
82.7 159.5 131.9 110.3
79.0 152.5 126.1 105.4
77.4 149.3 123.5 103.2
38
Nomura | Voltas
October 12, 2011
How well is Voltas positioned for a turn in the cycle?

Consistency of return ratios Voltas return ratios are significantly higher than the previous cycle (late 1990s) lows despite witnessing a falling trend since the FY07 peak. We note that this is in spite of an almost similar asset turnover ratio in FY99. The sharp improvement in return ratios is prima facie, attributed to tight working capital management and a sharp improvement in margins. Read across for Blue Star (a key competitor for Voltas in this segment): competitive cushion for Voltas might mean Blue Star has further downside risks on margins
Fig. 46: Return ratios peaked in FY07 but are still attractive
ROE 60% 50% 40% 30% 20% 10% 0%
Fig. 47: and much higher than the bottom

ROCE
60% 50% 40% 30% 20% 10% 0%

FY99 FY00 FY01 FY02 FY03 FY04
FY05
FY06
FY07
FY08
FY09
FY10
Source: Company data, Nomura research
Management of working capital and asset turnover In our opinion, the companys reduced asset turnover since FY07 is primarily led by a cyclical slowdown in order inflows from the domestic and international markets since the FY07/08 peak. However, despite cyclical pressures, the working capital (WC) cycle has held up and improved significantly since the previous cycle. We notice there is a tight rein over receivables days although inventory days have expanded.
FY11
39
Nomura | Voltas
October 12, 2011
Fig. 48: Asset t/o trend similar to ROE/ROCE

(x) 1.7 1.6 1.5 1.4 1.3 1.2 1.1
Fig. 49: Asset t/o ex cash is slightly better

(x) 2.2 2.1 2.0 1.9 1.8 1.7 1.6 1.5 1.4 1.3 1.2
40
Asset turnover
Fig. 50: WC cycle has compressed sharply, but has been inching up slightly since FY08 lows
Days of revenue
Net working capital cycle 40 30 20 10 0 -10 -20

Trajectory of growth Voltas has consistently maintained a positive double-digit growth trend, even during cyclical lows. Although its sales trend has yet to recover meaningfully from previous lows and the lull in order inflow cycle currently suggests that a pick-up is still some time away, margins have been on a steady uptrend and surprisingly depict very little impact during cyclical lows.
Nomura | Voltas
October 12, 2011
Fig. 51: Sales have been on a secular growth path and, along with compressing WC cycle, explain the rise in asset t/o
Sales growth
Fig. 52: Margins have been rising and cyclical sensitivity is typically +/- 100 bps; see downside from current levels
% of revenues
EBITDA margin
40% 30% 20% 10% 0% -10% -20% -30% -40%
10% 9% 8% 7% 6% 5% 4% 3% 2% 1% 0%
41
Source: Company data, Nomura research Source: Company data, Nomura research

The companys sales trend suggests that the business has yet to recover from previous cycle lows and its margins seem to be at risk. Risk to sales A slowdown in the international business, along with a domestic lull in order inflows, could mean that the sales trend is likely to remain at current levels or even compress further. We would assign moderate risk of further downside to sales growth. Risk to margins Current margin levels are clearly close to peak levels although the risk to margins is typically +/- 100 bps. The previous peak was 8% in FY08, followed by the trough of 6.5% in FY09.
What is consensus estimates building in?

Consensus FY12-13F EPS estimates are down 20-25% from peak levels already. We believe this broadly captures the risk to margins although the risks to sales remain.
Nomura | Voltas
October 12, 2011
Fig. 53: Consensus est. are down 20-25% from peak levels for FY12-13F, thus largely building in earnings risk
(INR) 17 16 15 14 13 12 11 10 Consensus EPS FY12 Consensus EPS FY13
May-10
Nov-10
May-11
Apr-10
Oct-10
Dec-10
Aug-10
Sep-10
Apr-11
Source: Bloomberg

The stock is trading slightly below its mid-cycle P/E and appears even cheaper on P/BV based on its 12-year historical data. However, compared with the latest five-year historical range, the stock is significantly below its mid-cycle multiples.
Fig. 54: Stock trading below mid-cycle P/E multiples
Voltas 1 year forward P/E chart (x)
Fig. 55: and 0.5 STDEV below mid-cycle P/B multiples

Voltas 1 year forward P/BV chart (x)
Aug-11
Jan-10
Jun-10
Jan-11
Jun-11
Jul-10
Feb-10
Mar-10
Feb-11
40 35 30 25 20 15 10 5 0
Mar-11
14 12 10 8 6 4 2 0
Mar-00
Mar-01
Jul-11
Mar-02
Mar-03
Mar-04
Mar-05
Mar-06
Mar-07
Mar-08
Mar-09
Mar-10
Mar-01
Mar-02
Mar-03
Mar-04
Mar-05
Mar-06
Mar-07
Mar-08
Mar-09
Mar-10
Mar-11
Impression: Attractive opportunity, although the business is highly correlated to global macro conditions
Voltas has underperformed the international and domestic markets by 35% over the past 12 months on slowing sales growth and margin concerns. We see limited near-term downside risks from current levels in the bear-case scenario. Under the extreme case, however, the share price could see further downside in the interim. From a long-term perspective, nevertheless, we think the stock is attractive currently and any correction should be seen as an opportunity to accumulate the stock. Our evaluation is based on: FY11F margin levels are close to peak levels and we see risk of 100-150bps downside correction from these levels. Slowing order flows will likely lead to slower sales growth in both the domestic and international segments. However, we believe the sales trend already reflects market pressure and further downside should be limited.
Mar-11
42
Nomura | Voltas
October 12, 2011
Consensus estimates are largely building in margin risks; we caution that further risk could emerge from sales continuing to slow from current levels. With earnings risk largely captured in the estimates, we believe current valuation is attractive from a long-term perspective. In our view, the stock could witness some downside upon further sales slowdown but that would be purely cyclical.
Cutting estimates ~30% and TP to INR150 to factor in adverse macro conditions

We cut our FY12-13F earnings by ~30% on increased concerns over its near-term sales and margins outlook in the electro-mechanical and unitary cooling product segments, due to adverse macro conditions. Our revised TP of INR150 is based on 14x (previously: 16.3x) Sep-13F EPS of INR10.85, suggesting 43% implied upside. We assume coverage of the stock with a Buy rating.
Risks that may impede the achievement of the target price

A delay in the pick-up of the domestic capex cycle would pose a key risk to our numbers and target price. Both the domestic Electro Mechanical Projects (EMP) (31% of revenue) and Engineering Products and Services (EPS) (9% of revenue) businesses are dependent on domestic capex spending and would likely be affected by any delay in capex.
43
Thermax
THMX.NS TMX IN .
EQUITY RESEARCH
Buy into the correction
October 12, 2011 Rating Up from Neutral Target price Reduced from 645 Closing price October 7, 2011 Potential upside
Visible earnings risk priced in, but may fare worse in an extreme case
Impression: Strong fundamentals; upgrade to Buy Given a 53% correction YTD, we think the stock now factors in the risks to business momentum. While we note that a severe global slowdown would drive further downside, we take this opportunity to upgrade the stock to Buy for the company's solid business fundamentals and strong track record during previous cycles. We base our evaluation on:
Buy
INR 500 INR 418 +19.6%
FY11 margins have yet to recover from the previous cycles low levels,
while risk from current levels should be, at best, 200 bps, in our view.
Anchor themes We believe Indias industrial sector offers significant opportunity over the coming years. We see potential opportunities in niche segments. Nomura vs consensus We are more cautious than consensus on near-term earnings strength given our expectation of an industrial slowdown.
Slower order flow and rising competition in the utility space are likely to
lead to slower sales growth over FY12-13F, we believe, though longerterm order flow should be driven by continued demand from process industries.
While consensus estimates on the stock are down 10-20%, we think

valuations already factor in the greater risk. Strongly poised for cyclical revival... Thermax remains among the biggest potential beneficiaries of demand for captive power plant and rising industrial capex, especially for process-flow industries such as metals, oil & gas and cement. Given a strong long-term opportunity and limited competition, we are positive on the fundamentals of the company and view the current downturn as a buying opportunity. ...but near-term slowdown drives 10-25% earnings cut Over FY12-13F, we expect both sales growth and margins to take a hit, so our TP moves lower to INR500 as we now rebase it to 14x (from 16x) on Sep-13F EPS of INR36 (from Mar-13F EPS). Nevertheless, with potential upside of 20% to our new TP, we upgrade the stock to Buy.
53,371 3,817 3,817 32.03 47.3 13.1 7.6 3.8 2.5 31.9
58,914 3,932 3,932 33.00 1.9 N/A 7.0 N/A N/A 26.4
59,818 4,127 4,127 34.64 8.1 12.1 6.6 3.1 2.4 28.2
69,648 4,780 4,780 40.11 21.6 N/A 5.7 N/A N/A 26.6
59,246 3,912 3,912 32.83 -5.2 12.7 6.7 2.6 2.3 22.4 N/A N/A N/A
70,019 4,671 4,671 39.20 19.4 10.7 5.4 2.3 2.7 22.8 net cash
Nomura | Thermax
October 12, 2011
Key data on Thermax


FY10 33,703 -20,713 12,990 -6,186 -3,300 3,505 3,947 -442 3,505 -20 519 4,004 -1,416 2,588 4 FY11 53,371 -36,787 16,584 -6,788 -4,597 5,199 5,740 -541 5,199 -41 579 5,737 -1,967 3,770 47 FY12F 59,818 -40,487 19,331 -8,146 -5,517 5,669 6,352 -683 5,669 -50 635 6,253 -2,126 4,127 0 FY13F 59,246 -39,281 19,965 -8,553 -6,068 5,343 6,116 -773 5,343 -50 635 5,928 -2,015 3,912 0 FY14F 70,019 -47,139 22,880 -9,409 -6,979 6,493 7,355 -863 6,493 -50 635 7,078 -2,406 4,671 0
(INR) 1000 900 800 700 600 500 400 A ug 11 S ep 11 N ov 10 M ay 11 F eb 11 J an 11 D ec 10 M ar 11 J un 11 O c t 11 A pr 11 J ul 11 60 80 100 Price Rel MSCI India 120

(%) Absolute (INR) Absolute (USD) Relative to index Market cap (USDmn) Estimated free float (%) 52-week range (INR) 3-mth avg daily turnover (USDmn) Major shareholders (%) RDA Holding & Trading Aga Arnawaz Rohitz 1M 3M 12M
-21.1 -31.3 -48.0 -25.3 -38.1 -53.0 -17.9 -17.4 -26.1 1,014.0 33.9 930/406 2.12
2,592 -1,149 1,443 -695 748
3,817 0 3,817 -1,246 2,570
4,127 0 4,127 -1,203 2,924
3,912 0 3,912 -1,141 2,772
4,671 0 4,671 -1,362 3,310
54.0 8.2
19.2 23.0 34.5 1.4 7.5 4.6 11.0 12.3 38.5 11.7 10.4 4.3 35.4 48.1 2.5 1.9 13.9 14.8
13.1 15.6 13.1 2.5 21.7 3.8 7.6 8.4 31.1 10.8 9.7 7.2 34.3 32.7 6.1 6.0 31.9 17.2
12.1 14.4 12.1 2.4 8.7 3.1 6.6 7.4 32.3 10.6 9.5 6.9 34.0 29.2 2.5 2.2 28.2 16.2
12.7 15.2 12.7 2.3 16.0 2.6 6.7 7.7 33.7 10.3 9.0 6.6 34.0 29.2 2.5 1.9 22.4 14.9
10.7 12.8 10.7 2.7 13.7 2.3 5.4 6.1 32.7 10.5 9.3 6.7 34.0 29.2 2.1 1.7 22.8 17.4
Notes
Near-term earnings and sales trend reflective of cyclical woes.
-2.6 -6.4 -9.4 -9.9 -9.9
58.4 45.4 48.3 47.3 47.3
12.1 10.7 9.0 8.1 8.1
-1.0 -3.7 -5.7 -5.2 -5.2
18.2 20.3 21.5 19.4 19.4
12.11 21.75 21.75 90.48 5.83
32.03 32.03 32.03 110.35 10.46
34.64 34.64 34.64 134.89 10.10
32.83 32.83 32.83 158.15 9.57
39.20 39.20 39.20 185.93 11.43
45
Nomura | Thermax
October 12, 2011
Cashflow(INRmn)
FY10 3,947 4,687 -2,002 6,632 -838 5,794 -2,260 -90 74 46 3,564 -695 0 39 98 -558 3,006 3,696 6,702 -6,623 FY11 5,740 -2,118 -1,326 2,295 -3,265 -970 1,289 7 147 -305 168 -1,246 0 1,400 473 626 794 6,702 7,496 -6,017 FY12F 6,352 888 -1,541 5,698 -1,500 4,198 -875 0 0 0 3,323 -1,203 0 -1,399 0 -2,603 720 7,496 8,217 -8,137 FY13F 6,116 -1,562 -1,430 3,124 -1,500 1,624 0 0 0 0 1,624 -1,141 0 0 0 -1,141 483 8,217 8,700 -8,619 FY14F 7,355 -1,266 -2,456 3,632 -1,500 2,132 0 0 0 2,132 -1,362 0 0 635 -727 1,406 8,699 10,105 -10,025 Notes
Cash-flow generation remains reasonable despite cyclical pressures.
Balancesheet(INRmn)
FY10 6,702 0 7,984 2,563 7,057 24,306 3,703 5,484
FY11 7,496 0 10,672 3,657 8,143 29,968 2,415 8,208
FY12F 8,217 0 11,309 4,016 8,586 32,127 3,290 9,025
FY13F 8,699 0 9,591 3,885 8,543 30,718 3,290 9,752
FY14F 10,105 0 11,354 4,669 9,278 35,405 3,290 10,389
Notes
Unlevered balance sheet provides room for growth.
297 33,790 80 20,581 1,813 22,474
289 40,880 1,479 22,193 2,951 26,623
289 44,730 80 24,536 2,934 27,550
289 44,049 80 21,100 2,917 24,097
289 49,373 80 22,821 3,210 26,111
441 22,914 94 0 238 10,543
588 27,211 520 0 238 12,911
588 28,138 520 0 238 15,835
588 24,685 520 0 238 18,606
588 26,699 520 0 238 21,916
10,782 33,790
13,149 40,880
16,073 44,730
18,845 44,049
22,154 49,373
1.08 172.7
1.13 126.8
1.17 113.4
1.27 106.9
1.36 129.9
net cash net cash
net cash net cash
net cash net cash
net cash net cash
net cash net cash
74.2 47.3 287.7 -166.2
63.8 30.9 212.2 -117.5
67.2 34.7 211.2 -109.3
64.4 36.7 212.0 -110.9
54.6 33.1 170.0 -82.3
46
Nomura | Thermax
October 12, 2011
How well is Thermax positioned for a turn in the cycle?

Consistency of return ratios We have seen significant improvement in return ratios for Thermax since the lows of the late 1990s. At the same time, the impact of cyclicality is clearly visible in the trend, though volatility is far lower than it was in the late 1990s. Even during the Lehman crisis, the low point was much higher than the late 1990s level. In absolute terms, even the current cyclical low ROE/ROCE in the 30-40% range is attractive, in our view.
Fig. 56: Return ratios have risen sharply since late 1990s crisis ...
%
Fig. 57: ... and peaked in FY08; current levels also attractive
%
50% 40% 30% 20% 10% 0% -10%

70% ROE 60% 50% 40% 30% 20% 10% 0% -10%
ROCE
FY99
FY00
FY01
FY02
FY03
FY04
FY05
FY06
FY07
FY08
FY09
FY10 FY10
FY04
FY05
FY06
FY07
FY08
FY09
FY10
FY11
Source: Company, Nomura research Source: Company, Nomura research
Managing working capital and asset turnover While rising sales and, hence, asset turnover, has greatly helped Thermax report a strong improvement in return ratios, we also note a significant decline in its workingcapital cycle since FY01. Over the past three years, its working-capital cycle has been flat despite pressure on receivable days.
Fig. 58: Asset turnover helps to explain the rise in return ratios
(x)
Fig. 59: Asset turnover ex cash is largely in sync, suggesting optimal cash management
(x)
1.8 1.6 1.4 1.2 1.0 0.8 0.6
Asset turnover
2.3 2.1 1.9 1.7 1.5 1.3 1.1 0.9
FY99
FY00
FY01
FY02
FY03
FY04
FY05
FY06
FY07
FY08
FY09
FY10
FY11
0.7
FY99
FY00
FY01
FY02
FY03
FY04
FY05
FY06
FY07
FY08
FY09
FY11
47
FY11
Nomura | Thermax
October 12, 2011
Fig. 60: Sharp compression in working-capital cycle over the past three years suggests purely sales-led fall in asset t/o
Days of revenue
120 100 80 60 40 20 0 -20 -40 -60
FY99
FY00
FY01
FY02
FY03
FY04
FY05
FY06
FY07
FY08
FY09
FY10
Trajectory of growth Thermaxs sales have been highly volatile around changes in cycles, but for the most part have grown 40% p.a. since FY03. Margins have also witnessed a sharp improvement since the FY02 bottom and have been moving within a narrow range of +/200 bps of 12% since FY04.
Fig. 61: Volatile sales growth trend, but largely above 40% pa
%
Fig. 62: Sharp rise in margins since FY02 and has been steady since then, within + / - 200 bps from 12%
% of revenues
70% 60% 50% 40% 30% 20% 10% 0% -10% -20% -30%
FY11
EBITDA margin
Sales growth
16% 14% 12% 10% 8% 6% 4% 2% 0% -2% -4%
FY99
FY00
FY01
FY02
FY03
FY04
FY05
FY06
FY07
FY08
FY09
FY10
FY99
FY00
FY01
FY02
FY03
FY04
FY05
FY06
FY07
FY08
FY09
FY10
FY11
Risks from a turn in cycle

The sales trend suggests that business is currently close to peak-cycle levels, though margins have not revived much since their FY10 bottom. Risk to sales There may be risk to sales growth for Thermax in the near term, as the recent surge in Thermaxs sales following a high share of utility orders looks unsustainable over the long term. Slowing industrial capex could add further pressure. As the sales growth chart suggests, in the past growth has suddenly fallen from the high 40s into negative territory during adverse times. We do not rule out a similar slowdown from current levels in case of a severe slowdown in the domestic industrial capex.
FY11
48
Nomura | Thermax
October 12, 2011
Risk to margins Margins are now much better than in previous peaks or lows as a result of sustained improvement in business performance. We are also confident because the lows during the Lehman crisis were much higher than the lows in the late 1990s. In our view, the next recession might not see margins collapsing below 8% levels, which is another 200 bps risk from current levels. In contrast, our estimates build in 50 bps of margin risk from current levels.

Even as we highlight the risk of a slowdown in sales growth and about a 200 bp risk to margins, we believe consensus estimates have yet to factor these in. So far we have seen 10-20% correction in consensus EPS estimates since peak levels for both FY12 and FY13, but factoring in the above, we see [10-15%] further downside in consensus estimates. As discussed next though, valuations have already corrected more than what consensus estimates suggest and in that sense we believe the markets are already building in the anticipated earnings risk.
Fig. 63: FY12/13F est. down just 10-20% from peak so far
INR
(INR) 53 48 43 38 33 28
Consensus EPS FY12
Consensus EPS FY13
Source: Bloomberg

While consensus estimates have yet to correct, as mentioned above we note that the stock is already trading below its12-year mean multiples. A correction in earnings would imply that the stock is still at around its mid-cycle trading range.
Jun-09 Jul-09 Aug-09 Sep-09 Oct-09 Nov-09 Dec-09 Jan-10 Feb-10 Mar-10 Apr-10 May-10 Jun-10 Jul-10 Aug-10 Sep-10 Oct-10 Nov-10 Dec-10 Jan-11 Feb-11 Mar-11 Apr-11 May-11 Jun-11 Jul-11 Aug-11 Sep-11
49
Nomura | Thermax
October 12, 2011
Fig. 64: Stock trading below 12-yr mean on P/E

Thermax 1-year forward P/E chart (x)
Fig. 65: and on P/B as well

Thermax 1-year forward P/B chart (x)
(x) 80 70 60 50 40 30 20 10 0
(x) 18 16 14 12 10 8 6 4 2
Mar-01
Mar-02
Mar-03
Mar-04
Mar-05
Mar-06
Mar-07
Mar-08
Mar-09
Mar-10
Mar-11
Mar-00
Mar-01
Mar-02
Mar-03
Mar-04
Mar-05
Mar-06
Mar-07
Mar-08
Mar-09
Mar-10
Strong fundamentals and correction offer an opportunity

With Thermax stock having underperformed overall markets 39% over the past 12 months, and the possibility that there may be further downside risks in the stock in the short term under a more extreme case scenario, on a long-term perspective, we think the stock offers value and that the correction offers an opportunity to accumulate. We base our evaluation on: FY11 margin levels have yet to recover from the previous cycles low levels. Risk from current levels should be 200 bps at best, in our view. Slower order flow should lead to slower sales growth. Thermaxs virtual exit from the utility space due to rising competition will also lead to a slowdown in sales, in our view. Longer-term, however, we remain convinced of TMXs ability to garner orders from a sustainable flow of industrial capex activity especially in the process flow domain such as oil & gas, metals, cements etc. Consensus estimates are down 10-20%, but we believe the valuation has already factored in the greater risk. Given Thermaxs fair-value range and its robust business fundamentals, we recommend Buy and would use any further downside as an enhanced buying opportunity.
Cutting estimates on slowdown concerns; upgrade to Buy on attractive valuation

While Thermaxs short-cycle products business is likely to continue in the near term, we believe there are risks to its projects business, especially in the power sector. Further, Thermax has witnessed high volatility during cycle turns and we believe that this time will be no different, though as discussed above, this is already built into the stock price now. Policy logjams impacting decision-making on large industrial and power capex are only likely to worsen the scenario, in our view. Thus, we have factored in significantly slower growth for Thermax over FY12-13, which is accompanied by drop in margins too; our new assumptions drive our earnings cut of 10-25% over FY12-13F. We expect a revival in FY14. Accordingly, we have cut our TP to INR500, now based on 14x Sep-13F EPS (from Mar13 earlier) of INR36. Our assigned multiple of 14x is slightly lower than the 16x we assigned earlier (which is also the past 5-6 years mean multiple). This is because we now align our valuation with the mean of the past 12 years, instead of just the past 6 years, as this is more relevant, in our view.
Mar-11
50
Nomura | Thermax
October 12, 2011
Despite our earnings and TP cuts, we believe the stock offers a potential upside of 19.6% to our new TP. Given Thermaxs fundamentally strong business, which, in our view, is nicely poised to benefit from the cyclical upturn post the current slowdown we upgrade the stock to a Buy rating. Nevertheless, we caution that in the event of an extreme macro slowdown, the stock could see near term pressure.
Risks to our call

Continued fuel shortages could stall demand for power projects. Thermaxs move towards the utility boiler business could hit profitability substantially given high competition in that segment. Firming coal prices would reduce demand for captive power plants. A severe global and domestic slowdown could lead to industrial capex deferral and that would be negative for Thermax.
51
ABB India
ABB.NS ABB IN .
EQUITY RESEARCH
Short circuit
October 12, 2011 Rating Remains Target price Reduced from 585 Closing price October 7, 2011 Potential downside
Premium valuations continue despite worsening performance on buyback expectations

Still expensive as near-term inflows remain elusive; Reduce ABB India appears suitably placed to tap into opportunities in Indias T&D equipment sector, in our view, with access to high-end technology, presence across the value chain, and superior execution. Furthermore, the parent sees ABB India as an outsourcing hub and, we believe, it could increase outsourcing from the Indian unit, given its cost differentials compared with the parents high-cost European base.
Reduce
INR 525 INR 666 -21.2%
Anchor themes Decades of under-investment in T&D infrastructure and a sudden march towards a power-sufficient nation promise opportunities for equipment manufacturers. Nomura vs consensus We are in line with consensus on both earnings and valuation.
While we remain positive on the long-term opportunity in the Indian T&D

space, we see PGCILs ordering activity picking up only in 2H FY12F, while SEB orders are still elusive. Rising SEB losses are also a concern, since they imply lower spending power with the distribution companies for new capex. Meanwhile, we foresee a slowdown in industrial capex as likely to hit the automation business in the near term; this business contributes ~40% of ABBs revenue and is highly dependent on the oil & gas and metal capex cycles.
Price competition has affected the sector due to the influx of Chinese
and Korean players and continued technology upgrading by select domestic vendors. On the positive side though, the company has largely accounted for losses from the rural electrification business and this should ease margin pressure, in our view.
Valuation: We have cut our estimates by 15-20% to factor in poor macro

conditions and reduced our TP to INR525. While earnings continue to disappoint, ABB has held on to steep valuations on expectations of further buybacks by the parent. Reaffirm Reduce on ~21% potential downside.
31 Dec Currency (INR) FY10 Actual Old FY11F New Old FY12F New Old FY13F New
62,871 632 1,399 6.60 -60.4 101.6 76.4 5.9 0.3 2.6
75,445 3,623 3,623 17.10 159.0 N/A 26.6 N/A N/A 14.0
72,302 3,112 3,112 14.69 122.5 45.7 30.9 5.3 0.3 12.1
94,307 5,778 5,778 27.27 59.5 N/A 16.0 N/A N/A 19.3
83,509 4,604 4,604 21.73 47.9 30.9 20.2 4.6 0.5 15.9 N/A N/A N/A
96,870 5,854 5,854 27.63 27.1 24.3 15.4 3.9 0.6 17.5 net cash
Nomura | ABB India
October 12, 2011
Key data on ABB India

Year-end 31 Dec Revenue Cost of goods sold Gross profit SG&A Employee share expense Operating profit EBITDA Depreciation Amortisation EBIT Net interest expense Associates & JCEs Other income Earnings before tax Income tax Net profit after tax Minority interests Other items Preferred dividends Normalised NPAT Extraordinary items Reported NPAT Dividends Transfer to reserves Valuation and ratio analysis FD normalised P/E (x) FD normalised P/E at price target (x) Reported P/E (x) Dividend yield (%) Price/cashflow (x) Price/book (x) EV/EBITDA (x) EV/EBIT (x) Gross margin (%) EBITDA margin (%) EBIT margin (%) Net margin (%) Effective tax rate (%) Dividend payout (%) Capex to sales (%) Capex to depreciation (x) ROE (%) ROA (pretax %) Growth (%) Revenue EBITDA EBIT Normalised EPS Normalised FDEPS Per share Reported EPS (INR) Norm EPS (INR) Fully diluted norm EPS (INR) Book value per share (INR) DPS (INR)

FY09 62,372 -45,664 16,708 -8,027 -3,892 4,789 5,274 -485 4,789 -256 726 5,259 -1,728 3,531 FY10 62,871 -48,538 14,334 -8,165 -4,901 1,267 1,784 -517 1,267 -174 855 1,948 -550 1,399 FY11F 72,302 -54,067 18,235 -8,982 -5,391 3,862 4,425 -564 3,862 -200 984 4,645 -1,533 3,112 FY12F 83,509 -61,196 22,313 -10,329 -6,011 5,973 6,625 -652 5,973 -250 1,253 6,975 -2,371 4,604 FY13F 96,870 -70,490 26,380 -11,982 -6,733 7,666 8,409 -744 7,666 -250 1,453 8,869 -3,014 5,854
(INR) 950 900 850 800 750 700 650 600 A ug 11 S ep 11 N ov 10 M ay 11 F eb 11 J an 11 D ec 10 M ar 11 J un 11 O c t 11 A pr 11 J ul 11 Price Rel MSCI India 120 110 100 90 80 70

(%) Absolute (INR) Absolute (USD) Relative to index Market cap (USDmn) Estimated free float (%) 52-week range (INR) 3-mth avg daily turnover (USDmn) Major shareholders (%) ABB Asea Brown Boveri LIC 1M 3M 12M
-20.9 -22.2 -27.4 -26.2 -29.9 -34.5 -14.8 2,879.6 25.0 955/595 1.89 -6.0 -2.2
3,531 0 3,531 -496 3,035
1,399 -766 632 -496 136
3,112 0 3,112 -437 2,675
4,604 0 4,604 -646 3,958
5,854 0 5,854 -822 5,032
69.1 9.5
40.2 31.5 40.2 0.3 42.0 5.9 26.0 28.6 26.8 8.5 7.7 5.7 32.9 14.0 1.5 1.9 15.5 9.5
101.6 79.5 224.7 0.3 65.6 5.9 76.4 107.5 22.8 2.8 2.0 1.0 28.2 78.4 1.4 1.7 2.6 2.5
45.7 35.7 45.7 0.3 146.5 5.3 30.9 35.4 25.2 6.1 5.3 4.3 33.0 14.0 1.7 2.1 12.1 7.0
30.9 24.2 30.9 0.5 26.9 4.6 20.2 22.5 26.7 7.9 7.2 5.5 34.0 14.0 2.4 3.1 15.9 9.7
24.3 19.0 24.3 0.6 20.4 3.9 15.4 16.9 27.2 8.7 7.9 6.0 34.0 14.0 1.4 1.8 17.5 11.3
Notes
We expect margins to recover but remain lower than normal levels
-8.8 -31.5 -34.7 -35.0 -35.0
0.8 -66.2 -73.5 -60.4 -60.4
15.0 148.1 204.7 122.5 122.5
15.5 49.7 54.7 47.9 47.9
16.0 26.9 28.3 27.1 27.1
16.66 16.66 16.66 114.38 2.34
2.98 6.60 6.60 114.38 2.34
14.69 14.69 14.69 127.64 2.06
21.73 21.73 21.73 146.32 3.05
27.63 27.63 27.63 170.07 3.88
53
Nomura | ABB India
October 12, 2011
Cashflow(INRmn)
Year-end 31 Dec EBITDA Change in working capital Other operating cashflow Cashflow from operations Capital expenditure Free cashflow Reduction in investments Net acquisitions Reduction in other LT assets Addition in other LT liabilities Adjustments Cashflow after investing acts Cash dividends Equity issue Debt issue Convertible debt issue Others Cashflow from financial acts Net cashflow Beginning cash Ending cash Ending net debt
FY09 5,274 -631 -1,258 3,385 -916 2,469 442 0 -39 -656 2,216 -496 0 0 39 -457 1,759 3,482 5,241 -5,241 FY10 1,784 1,017 -635 2,166 -860 1,307 1 0 -45 -137 1,126 -496 0 0 FY11F 4,425 -2,706 -749 970 -1,200 -230 0 0 0 137 -93 -437 0 0 FY12F 6,625 19 -1,368 5,275 -2,000 3,275 0 0 0 0 3,275 -646 0 0 FY13F 8,409 385 -1,811 6,983 -1,336 5,647 0 0 0 5,647 -822 0 0
-496 630 5,241 5,871 -5,871
-437 -530 5,871 5,341 -5,341
-646 2,629 5,341 7,970 -7,970
-822 4,825 7,970 12,795 -12,795
Balancesheet(INRmn)
As at 31 Dec Cash & equivalents Marketable securities Accounts receivable Inventories Other current assets Total current assets LT investments Fixed assets Goodwill Other intangible assets Other LT assets Total assets Short-term debt Accounts payable Other current liabilities Total current liabilities Long-term debt Convertible debt Other LT liabilities Total liabilities Minority interest Preferred stock Common stock Retained earnings Proposed dividends Other equity and reserves Total shareholders' equity Total equity & liabilities Liquidity (x) Current ratio Interest cover Leverage Net debt/EBITDA (x) Net debt/equity (%) Activity (days) Days receivable Days inventory Days payable Cash cycle
FY09 5,241 0 28,577 7,294 6,380 47,493 169 7,895
FY10 5,871 0 29,260 6,979 7,153 49,262 168 8,238
FY11F 5,341 0 33,675 7,769 8,226 55,010 168 8,874
FY12F 7,970 0 36,606 8,294 9,501 62,371 168 10,222
FY13F 12,795 0 39,810 9,554 11,021 73,179 168 10,815
Notes
Clean balance sheet with net cash
0 55,556 29,869 1,450 31,320 0 -1 31,319
0 57,668 31,630 1,846 33,477 0 -46 33,431
0 64,052 35,242 1,808 37,049 0 -46 37,003
0 72,761 39,879 1,921 41,800 0 -46 41,754
0 84,162 45,941 2,228 48,169 0 -46 48,123
424 23,813
424 23,813
424 26,625
424 30,583
424 35,615
24,237 55,556
24,237 57,668
27,049 64,052
31,007 72,761
36,039 84,162
1.52 18.7
1.47 7.3
1.48 19.3
1.49 23.9
1.52 30.7
net cash net cash
net cash net cash
net cash net cash
net cash net cash
net cash net cash
170.7 54.8 245.7 -20.2
167.9 53.7 231.2 -9.7
158.9 49.8 225.7 -17.1
154.0 48.0 224.6 -22.6
144.0 46.2 222.2 -32.0
54
Nomura | ABB India
October 12, 2011
How well is ABB India best positioned for a turn in the cycle?
Consistency of return ratios ABB India has witnessed severe erosion in its return profile since FY08. In fact, returns since FY06 could arguably be lower than what is visible, given that growth in the rural electrification business then had pumped-up returns during that period.
Fig. 66: Sharp deterioration in return profile
ROE 40% 35% 30% 25% 20% 15% 10% 5% 0%
Fig. 67: on a move into rural business

ROCE 40% 35% 30% 25% 20% 15% 10% 5% 0%
FY00 FY01 FY02 FY03 FY04 FY05 FY06 FY07 FY08 FY09 FY10 FY11
55
FY00
FY01
FY02
FY03
FY04
FY05
FY06
FY07
FY08
FY09
FY10
FY11
Management of working capital and asset turnover Continues to suffer from the aftermath of the FY09 credit crisis-impinged slowdown, as order flows have yet to pick up for the company. Sales are thus still to pick up, as the products business is not ramping-up as yet. Furthermore, the company has also lost market share in key segments, thus impacting its growth profile. Meanwhile, working capital continues to rise and, together with slowing sales, is impacting asset turnover.
Nomura | ABB India
October 12, 2011
Fig. 68:
(x) 1.4 1.4 1.3 1.3 1.2 1.2 1.1 1.1 1.0 1.0 0.9
Slow sales growth impacting asset t/o

Asset turnover
Fig. 69: though cash management has been fine

(x) 1.8 1.7 1.6 1.5 1.4 1.3 1.2 1.1 1.0 Asset turnover (ex cash)
FY00
FY01
FY02
FY03
FY04
FY05
FY06
FY07
FY08
FY09
FY10
FY11
FY00
FY01
FY02
FY03
FY04
FY05
FY06
FY07
FY08
FY09
FY10
Fig. 70: Working capital has been rising steadily since FY05
Days of revenue
Net working capital cycle 120 100 80 60 40 20 0
FY00
FY01
FY02
FY03
FY04
FY05
FY06
FY07
FY08
FY09
FY10
Trajectory of growth We gain very little confidence in ABBs ability to sharply ramp-up growth and margin profile from the trends, as depicted in the charts below. Continued competition in the T&D segment is likely to exert further pressure on recovery.
FY11
FY11
56
Nomura | ABB India
October 12, 2011
Fig. 71: Revenues are yet to recover from FY09 collapse

Sales growth
Fig. 72: While margins continue to deteriorate

EBITDA margin
60% 50% 40% 30% 20% 10% 0% -10% -20%

16% 14% 12% 10% 8% 6% 4% 2% 0%
FY00
FY01
FY02
FY03
FY04
FY05
FY06
FY07
FY08
FY09
FY10
FY05
FY06
FY07
FY08
FY09
FY10
FY11

Trends suggest that ABB has yet to recover from the aftermath of the previous cycle. Risk to sales Given that the order book has expanded marginally over the past few quarters, we expect that sales should revive, albeit marginally. However, headwinds for a sharp revival appear very high. Risk to margins Margins are already at the bottom of the cycle and this is due mainly to the impact of the rural electrification business. While we expect margins to revive from these levels, the extent will depend on a revival in ABBs pricing power in key product segments.
What is consensus estimates building in?

Fig. 73: Estimates down 50-60% but we see further risk as 1HCY11 has been worse than expected
(INR) 75 65 55 45 35 25 15 Consensus EPS FY12 Consensus EPS FY13
Aug-09
Aug-10
Source: Bloomberg
Aug-11
Dec-09
Dec-10
Jun-09
Jun-10
Feb-10
Feb-11
Jun-11
Apr-09
Oct-09
Apr-10
Oct-10
Apr-11
FY11
57
Nomura | ABB India
October 12, 2011
What is valuation factoring in?

Fig. 74: The stock continues to trade at premium valuations
(x) 275 225 175 125 75 25 1 yr fwd P/E chart +1STDEV Mean -1STDEV
Fig. 75: despite a disastrous performance on buyback expectations

(x) 18 16 14 12 10 8 6 4 2 0 1 yr fwd P/B chart +1STDEV Mean -1STDEV
Mar-00
Mar-01
Mar-02
Mar-03
Mar-04
Mar-05
Mar-06
Mar-07
Mar-08
Mar-09
Mar-10
Mar-00
Mar-01
Mar-02
Mar-03
Mar-04
Mar-05
Mar-06
Mar-07
Mar-08
Mar-09
Mar-10
Mar-11
Cutting estimates by 15-20%; TP reduced to INR525

We are building in more caution on account of a worsening global macro, as we cut our estimates by 15-20%. Our earnings revisions are driven by reducing hopes of strong pick up in execution and margins. We value ABB India at 20x (unchanged) Sep 13F (from Mar-13F earlier) EPS of INR26.3, which is lower than the historical average but justified, in our view, given that the company is losing market share, leading to lower sustainable lower ROE from the earlier average levels (adjusted for the difference between expected and actual earnings). Our target multiple for ABB is still higher than that used for CRG because ABB continues to be more technology-driven and has higher potential of winning more technologyintensive orders vs CRG.
Investment risks
Upside risks include: 1) Sharper-than-expected recovery in the industrial and power products segment; and 2) a substantial decline in commodity prices, thus benefitting margins.
Mar-11
58
-25
October 12, 2011
Bharat Electronics (BHE IN, Not Rated)

Company background
Bharat Electronics (BHE) caters primarily to the defence sector through its nine manufacturing units. The defence sector contributed 80% of its sales for FY11, with the remaining coming from the civilian sector. Research and Development is the core strength of BHE, which has collaborated with various leading research institutes, including DRDO. The analysis of the companys turnover for FY11 indicates that 57% was due to BHE-designed products, 21% due to products developed by DRDO and other indigenous agencies, and the remaining due to foreign technology. BHE expects the modernization drive of the countrys security forces to provide a significant business opportunity for the company.

Consistency of return ratios Return ratios have come off their peaks in FY06 and are even lower than previous lows. All the parameters are close to the bottom, raising the key question of whether the problem is cyclical or structural. Incidentally, Bharat Electronics operates in the defence sector, which is not cyclical.
Fig. 76: Sharp reversal in return ratios
35% 33% 31% 29% 27% 25% 23% 21% 19% 17% 15% 20% 15% 25% 30%
Fig. 77: now lower than previous lows

40% ROCE 35%
ROE
FY99
FY00
FY01
FY02
FY03
FY04
FY05
FY06
FY07
FY08
FY09
FY10
FY99
FY00
FY01
FY02
FY03
FY04
FY05
FY06
FY07
FY08
FY09
FY10
FY11
Management of working capital and asset turnover The asset turnover has been falling consistently, primarily due to poor sales. Asset turnover excluding cash is close to FY00 lows, while overall asset turnover is worse, implying poor cash management by the company. Working capital cycle has improved after worsening from the lows of FY04. We notice that receivable and inventory cycle has deteriorated after an improvement in the interim.
FY11
59
October 12, 2011
Fig. 78: Asset turnover has fallen sharply since FY05

(x)
Fig. 79: Asset turnover ex cash is also close to late 90s low
(x)
0.80 0.75 0.70 0.65 0.60 0.55 0.50 0.45 0.40 Asset turnover
1.10 1.05 1.00 0.95 0.90 0.85 0.80 0.75 Asset turnover (ex cash)
FY99
FY00
FY01
FY02
FY03
FY04
FY05
FY06
FY07
FY08
FY09
FY10
FY11
0.70
FY99
FY00
FY01
FY02
FY03
FY04
FY05
FY06
FY07
FY08
FY09
FY10
Fig. 80: WC cycle is slightly better after worsening from their FY04/05lows
Days of revenue
60 40 20 0 (20) (40) (60) (80) (100)
FY99
FY00
FY01
FY02
FY03
FY04
FY05
FY06
FY07
FY08
FY09
FY10
Trajectory of growth Sales growth is on a constant decline, while margins are returning to lows of FY99 after peaking in the FY06-FY09 period.
FY11
FY11
60
October 12, 2011
Fig. 81: Falling sales growth is the key culprit
Fig. 82: Margins only slightly better since late 90s and down from FY05-09 peak, possibly due to operating leverage
% of revenues
30% 25% 20% 15% 10% 5% 0%
Sales growth
30% 25% 20% 15% 10% 5% EBITDA margin
FY99
FY00
FY01
FY02
FY03
FY04
FY05
FY06
FY07
FY08
FY09
FY10
FY11
0%
FY99
FY00
FY01
FY02
FY03
FY04
FY05
FY06
FY07
FY08
FY09
FY10

Bharat Electronics operates primarily in the defence sector, which is not cyclical. However, defence orders are typically lumpy, and as such can impact the sales trend and profitability of a company temporarily. Current trends suggest that Bharat Electronics has been suffering from poor sales growth, which is also impacting margins, and slow order decisions in the defence segment could be a reason for this.
Consensus estimates
Consensus EPS estimates are down 15-16% for Bharat Electronics from its peak levels.
Fig. 83: Consensus estimate down 15-16%
INR
Jan-11
May-10
May-11
Feb-10
Mar-11
Feb-11
Feb-11
Aug-10
Sep-10
Jun-11
160 155 150 145 140 135 130 125 120 115 110
Consensus EPS FY12
Consensus EPS FY13
Oct-10
Oct-10
Oct-10
Apr-10
Oct-10
Oct-09
Apr-11
Apr-11
Aug-11
Source: Bloomberg
Sep-11
Aug-10
Sep-10
FY11
61
October 12, 2011
Consensus valuation
On consensus numbers, the stock is trading at average P/BV and slightly above on P/E on 12-year history.
Fig. 84: Stock still trading above 12 yr mean P/E range
Bharat Electronics 1 year forward P/E chart (x)
Fig. 85: and close to mean P/BV levels

Bharat Electronics 1 year forward P/BV chart (x)
25 20 15 10 5 0
5.0 4.5 4.0 3.5 3.0 2.5 2.0 1.5 1.0 0.5 0.0
+1STDEV -1STDEV
Mar-00
Mar-01
Mar-02
Mar-03
Mar-04
Mar-05
Mar-06
Mar-07
Mar-08
Mar-09
Mar-10
Mar-00
Mar-01
Mar-02
Mar-03
Mar-04
Mar-05
Mar-06
Mar-07
Mar-08
Mar-09
Mar-10
Source: Company, Bloomberg
Mar-11
Summary
Bharat Electronics stock has outperformed the SENSEX by 4% over the past 12 months. Most of the parameters are at their lows, even though Bharat Electronics commands a superior position in the defence sector, necessitating an analysis of structural issues in addition to cyclical problems. Sales growth has been consistently on decline over the past 12 years. Margins have come off from their FY06-FY09 peak period and are close to their FY09 lows. Consensus estimates are down 15-16% from their peak, though valuation is still well above mean multiples.
Mar-11
62
October 12, 2011
BEML (BEML IN, Not rated)

Company background
BEML Limited operates in Indias core sectors such as Defence, Rail, Power, Mining and Infrastructure equipment supply. As part of its globalization strategy, the company has expanded its global reach by opening a local company at Indonesia and Brazil recently in addition to its Malaysia and China offices. The company operates under three major business verticals Mining & Construction, Defence and Rail & Metro. The Rail & Metro segment accounted for 37% of revenue in FY11, while Earth Moving and Defence accounted for 41% and 20%, respectively. The company has drawn up VISION 2013 with an ambitious growth rate of 12% CAGR for crossing INR 50 bn turnover by FY14 and achieving the INR 100 bn mark by FY17.

Consistency of return ratios Return ratios are back to single digits after experiencing a spike during FY05-FY09. A sharp improvement was seen in FY05 across the board but it has been followed by secular downfall since then.
Fig. 86: Sharp change in FY05 followed by consistent declining trend in the return ratios
30% ROE 25% 20% 15% 10% 5% 0%
Fig. 87: suggests a temporary business change impact in FY05, which is now fading
30% 25% 20% 15% 10% 5%
ROCE
FY99
FY00
FY01
FY02
FY03
FY04
FY05
FY06
FY07
FY08
FY09
FY10
FY11
FY99
FY00
FY01
FY02
FY03
FY04
FY05
FY06
FY07
FY08
FY09
FY10
Management of working capital and asset turnover Asset turnover has been volatile over the years, reflecting the sector cyclical trends; however, it is now even worse than the previous lows. The working capital cycle peaked in FY04 but has deteriorated sharply since then, except in FY11
FY11
63
0%
October 12, 2011
Fig. 88: Asset turnover broadly mirrors sector cycle

(x)
Fig. 89: but bit more volatile and now worse than late 90s
(x)
1.10 1.05 1.00 0.95 0.90 0.85 0.80 0.75 0.70 0.65 0.60
Asset turnover
1.4 1.3 1.2 1.1 1.0 0.9 0.8 0.7 0.6
FY99
FY00
FY01
FY02
FY03
FY04
FY05
FY06
FY07
FY08
FY09
FY10
FY99
FY00
FY01
FY02
FY03
FY04
FY05
FY06
FY07
FY08
FY09
FY10
FY11
Fig. 90: WC cycle improved sharply until FY04 and has been worsening since then except for a sudden plunge in FY11
Days of revenue
300 250 200 150 100 50 0 -50
FY99
FY00
FY01
FY02
FY03
FY04
FY05
FY06
FY07
FY08
FY09
FY10
Trajectory of growth Sales growth has been slowing gradually for the company and is into negative territory now. Sales CAGR over FY99-11 is a mere 6.6%, making it the lowest growth profile across the companies in this analysis. The profitability of BEML has worsened with EBITDA declining at a 14% CAGR since FY05 and margins reaching all time lows.
FY11
FY11
64
October 12, 2011
Fig. 91: Sales growth has only occasionally been above 15%
Fig. 92: Margin movement explains ROE/ROCE pattern since FY04; EBITDA CAGR since FY05 is -14%
% of revenues
25% 20% 15% 10% 5% 0% -5% -10%
Sales growth
18% 16% 14% 12% 10% 8% 6% 4% 2% 0%
EBITDA margin
FY99
FY00
FY01
FY02
FY03
FY04
FY05
FY06
FY07
FY08
FY09
FY10
FY11
FY99
FY00
FY01
FY02
FY03
FY04
FY05
FY06
FY07
FY08
FY09
FY10

Poor sales and margins trend are approaching levels last seen in previous cycle lows.
Consensus estimates
Consensus EPS estimates for BEML are down 30-35% from peak levels.
Fig. 93: Consensus est. cut 30-35% from peak
INR
100 90 80 70 60 50 40
Consensus EPS FY12
Consensus EPS FY13
Nov-10
Apr-11
Aug-11
Aug-11
Sep-11
Aug-10
May-11
May-11
Source: Bloomberg
May-11
Sep-11
Jun-11
Jan-11
Jun-11
Jul-11
Feb-11
Feb-11
Feb-11
Mar-11
Jul-11
FY11
65
October 12, 2011
Consensus valuation
While the stock has fallen significantly from peak levels, we note that it is currently trading at -1 standard deviation of 12-year mean trading levels. However, the current valuation is in line with the mean multiple levels the stock used to trade at between FY99-FY05.
Fig. 94: Stock trading close to -1 Std. deviation of mean
BEML 1 year forward P/E chart (x)
Fig. 95: on both P/E and P/BV, but is there value?

BEML 1 year forward P/BV chart (x)
35 30 25 20 15 10 5 0
7 6 5 4 3 2 1 0
Mar-00
Mar-01
Mar-02
Mar-03
Mar-04
Mar-05
Mar-06
Mar-07
Mar-08
Mar-09
Mar-10
Mar-00
Mar-01
Mar-02
Mar-03
Mar-04
Mar-05
Mar-06
Mar-07
Mar-08
Mar-09
Mar-10
Mar-11
Summary
BEML stock underperformed the SENSEX by 36% over past 12 months. Return and turnover ratios are at the bottom seen during the previous cycle; the working capital cycle has been worsening though we notice one-off improvement in FY11. Sales growth has been steadily falling since FY05 and turned negative in FY11. EBITDA has been declining at a 14% CAGR since FY05, with margins approaching previous cycle lows. Consensus estimates are building in around 30-35% downside from current level. Valuation is close to -1 standard deviation of 12-year mean P/E but in line with mean historical FY99-05 trading multiples.
Mar-11
66
October 12, 2011
AIA Engineering (AIAE IN, Not rated)

Company background
AIA Engineering (AIAE) focuses on the design, development and manufacturing of castings used in various industries including cement, mining and power. AIAE is the second-largest Hi-Chrome casting producer in the world. AIAE provides sales and services in more than 75 countries through its wholly owned subsidiary Vega Industries. AIAE has also collaborated with Southwestern Corp, UK, for process improvements.

Consistency of return ratios AIA Engineering (AIAE IN) returns are seen to be in line with business cycles. AIAE has provided return on equity above 20% except in the past two years.
Fig. 96: Return ratios have declined since FY09 levels
75% ROE 65% 55% 45% 35% 25% 15% 25% 23% 21% 19% 17%
Fig. 97: though they are in line with business cyclicality

27% ROCE
FY99
FY00
FY01
FY02
FY03
FY04
FY05
FY06
FY07
FY08
FY09
FY10
FY11
15%
FY99
FY00
FY01
FY02
FY03
FY04
FY05
FY06
FY07
FY08
FY09
FY10
Management of working capital and asset turnover Total as well as ex-cash asset turnover are at the bottom and seem to be dictated by business cycles Working capital cycle also follows similar trend over FY03-FY08 and improved since FY09. Receivable days have improved continuously except in last two years while inventory days have been cyclical.
FY11
67
October 12, 2011
Fig. 98: Asset turnover has deteriorated consistently

(x)
Fig. 99: ex cash too

(x)
1.5 1.4 1.3 1.2 1.1 1.0 0.9 0.8 0.7 0.6
Asset turnover
1.7 1.6 1.5 1.4 1.3 1.2 1.1 1.0 0.9 0.8
FY99
FY00
FY01
FY02
FY03
FY04
FY05
FY06
FY07
FY08
FY09
FY10
FY99
FY00
FY01
FY02
FY03
FY04
FY05
FY06
FY07
FY08
FY09
FY10
FY11
Fig. 100: WC cycle largely flat except for FY02 and FY09
Days of revenue
260 240 220 200 180 160 140 120 100 80
FY99
FY00
FY01
FY02
FY03
FY04
FY05
FY06
FY07
FY08
FY09
FY10
Trajectory of growth Sales grew at 23.7% CAGR while EBITDA has been at a 26.2% CAGR over the past 10 years. However, sales growth shows high cyclicality over the years.
FY11
FY11
68
October 12, 2011
Fig. 101: Sales growth volatile amidst cyclicality

60% 50% 40% 30% 20% 10% 0% -10% -20% Sales growth
Fig. 102: Margins seem cyclical though trending higher

% of revenues
29% 27% 25% 23% 21% 19% 17% 15%
EBITDA margin
FY99
FY00
FY01
FY02
FY03
FY04
FY05
FY06
FY07
FY08
FY09
FY10
FY99
FY00
FY01
FY02
FY03
FY04
FY05
FY06
FY07
FY08
FY09
FY10
FY11

As of FY11 levels, sales trends are still recuperating from the post-Lehman slowdown, though margins were still falling. Trends suggest that overall the company is yet to recover from previous cycle lows.
Consensus estimates
Consensus estimates are down 15-35% from their peak, with the bulk of the cut in near-term estimates.
Fig. 103: Consensus estimates down 15-35% from peak
INR
32 30 28 26 24 22
Consensus EPS FY12
Consensus EPS FY13
Source: Bloomberg
Jan-10 Feb-10 Feb-10 May-10 Jun-10 Jun-10 Jul-10 Jul-10 Aug-10 Aug-10 Oct-10 Nov-10 Nov-10 Jan-11 Feb-11 Feb-11 Feb-11 Mar-11 Apr-11 Apr-11 May-11 May-11 May-11 Jun-11 Jun-11 Jul-11 Jul-11 Aug-11 Aug-11 Aug-11 Sep-11 Sep-11
20
FY11
69
October 12, 2011
Consensus valuation
The stock is now trading lower than the average valuation it got over the last 12 years, while valuations are still almost twice that of the post-Lehman lows.
Fig. 104: Stock trading between mean and -1 Std deviation P/E Fig. 105: and close to -1 Std. deviation on P/BV
AIA Engineering 1 year forward P/E chart (x) AIA Engineering 1 year forward P/B chart (x)
25 23 21 19 17 15 13 11 9 7 5
1 yr fwd P/E chart Mean
+1STDEV -1STDEV
Mar-06
Mar-07
Mar-08
Mar-09
Mar-10
Mar-06
Mar-07
Mar-08
Mar-09
Mar-10
Mar-11
Summary
AIAE stock performance has been at par with the SENSEX over the past 12 months. Almost all data points show high cyclicality in business. Return and turnover ratios are at the bottom while margins showing downturn since FY08. Consensus estimates are building in around 15-35% downside from their peak.
Mar-11
70
October 12, 2011
Carborundum Universal (CU IN, Not rated)

Company background
Carborundum Universal (CU) manufactures and supplies abrasives, ceramics and electro minerals from its 25 factories spread over seven countries. CU was incorporated in 1954 as a joint venture between Carborundum Company, USA, Universal Grinding Wheel Company, UK and Murugappa Group, India. The Murugappa Group is one of India's leading conglomerates, with sales over USD 3.14bn. CU has shown consistent growth over the past ten years on account of its successful acquisitions as part of the backward integration.

Consistency of return ratios Despite business cyclicality being evident, the company has maintained return ratios of 15-20% throughout, in line with peer averages. ROE and ROCE are now back to normal levels after bottoming out in FY10.
Fig. 106: Return ratios in line with peers maintained throughout
54% 49% 44% 39% 34% 29% 24% 19% 14%
Fig. 107: though lower than previous cycle
ROE
49% 44% 39% 34% 29% 24% 19% 14%
ROCE
FY99
FY00
FY01
FY02
FY03
FY04
FY05
FY06
FY07
FY08
FY09
FY10
FY99
FY00
FY01
FY02
FY03
FY04
FY05
FY06
FY07
FY08
FY09
FY10
FY11
Management of working capital and asset turnover Asset turnover ratio shows similar pattern as return ratios with the exception of FY08, when return ratios hit a high but asset turn was at a low. The asset turnover dip in FY08-FY09 was due to the cyclical impact on sales and working capital, as per our reading. Working capital cycle has improved despite cyclical pressures. Receivables have contributed to improvement, while inventory has remained an issue.
FY11
71
October 12, 2011
Fig. 108: Asset turnover show signs of cyclicality

(x)
Fig. 109: no major difference in asset turnover ex cash

(x)
1.10 1.05 1.00 0.95 0.90 0.85 0.80 0.75 0.70 Asset turnover
1.10 1.05 1.00 0.95 0.90 0.85 0.80 0.75 Asset turnover (ex cash)
FY99
FY00
FY01
FY02
FY03
FY04
FY05
FY06
FY07
FY08
FY09
FY10
FY99
FY00
FY01
FY02
FY03
FY04
FY05
FY06
FY07
FY08
FY09
FY10
FY11
Fig. 110: Net WC cycle has shrunk sharply despite cyclicality

Days of revenue
130 125 120 115 110 105 100 95 90 85 80
FY99
FY00
FY01
FY02
FY03
FY04
FY05
FY06
FY07
FY08
FY09
FY10
Trajectory of growth Carborundum Universal has managed sales growth at ~13.8% CAGR over the past 10 years, and the trend has been of a consistent double-digit growth rate. Margins are also seen in the range of 17-19%, providing ~13.2% CAGR in EBITDA over the past ten years. We note that margins bottomed at 17% post Lehman crisis.
FY11
FY11
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October 12, 2011
Fig. 111: Sales growth has consistently been in double digits

30% 25% 20% 15% 10% 5% 0% -5% -10% -15% Sales growth
Fig. 112: Cyclical margins; +/- 100 bps of 18% since FY05
% of revenues
23% 22% 21% 20% 19% 18% 17% 16% 15% 14% EBITDA margin
FY99
FY00
FY01
FY02
FY03
FY04
FY05
FY06
FY07
FY08
FY09
FY10
FY11
FY99
FY00
FY01
FY02
FY03
FY04
FY05
FY06
FY07
FY08
FY09
FY10

Both sales and margins trends suggest a revival of the companys business cycle from the post-Lehman lows witnessed in FY09.
Consensus estimates
Consensus EPS estimates have consistently been rising over the past 18 months or so.
Fig. 113: Consensus estimates
INR
28 26 24 22 20 18 16 14 12
Consensus EPS FY12
Consensus EPS FY13
10 Jan-10 Mar-10 May-10 Jul-10

Source: Bloomberg
Sep-10 Nov-10 Jan-11 Mar-11 May-11 Jul-11
FY11
73
October 12, 2011
Consensus valuation
The stock is trading well above its mean P/E and P/BV multiple.
Fig. 114: Stock trading at +1 Std deviation of P/E mean
Carborundum Universal 1 year forward P/E chart (x)
Fig. 115: and close to the same on P/BV

Carborundum Universal 1 year forward P/BV chart (x)
25 20 15 10 5 0
1 yr fwd P/E chart Mean
+1STDEV -1STDEV
6 5 4 3 2 1 0
+1STDEV -1STDEV
Mar-00
Mar-01
Mar-02
Mar-03
Mar-04
Mar-05
Mar-06
Mar-07
Mar-08
Mar-09
Mar-10
Mar-00
Mar-01
Mar-02
Mar-03
Mar-04
Mar-05
Mar-06
Mar-07
Mar-08
Mar-09
Mar-10
Mar-11
Summary
Carborundum Universal stock outperformed overall markets by 51% over the past 12 months. Carborundum Universal has managed to provide consistent returns in the range of 15-20%. Sales growth witnessed a dip in FY-08-FY09 due to cyclical pressure; however, both sales and working capital returned to average in FY11. The company has maintained a healthy EBITDA margin of +/-100bps of 18% since 2005. Consensus estimates have increased consistently.
Mar-11
74
October 12, 2011
Blue Star (BLSTR IN, Not rated)

Company background
Blue Star is India's largest central air-conditioning company, with an annual turnover of ~INR 29 bn, a network of 29 offices, 6 manufacturing facilities and over 1,200 dealers. Blue Star primarily focuses on the corporate and commercial markets. The company has recently started pursuing the residential segment with its wide range of room air conditioners. Blue Star has business alliances with world renowned technology leaders such as Rheem Mfg Co, USA; Hitachi, Japan; Eaton-Williams, UK; Thales e-Security Ltd., UK; and Jeol, Japan to offer superior products and solutions to customers.

Consistency of return ratios Despite a sharp fall-off since FY08, Blue Stars ROE/ROCE profile is still better than peer average at 25%+ levels.
Fig. 116: Above peer average return ratios
78% ROE 68% 58% 48% 38% 28% 18%
Fig. 117: despite fall from peak in FY08

65% 60% 55% 50% 45% 40% 35% 30% 25% ROCE
FY99
FY00
FY01
FY02
FY03
FY04
FY05
FY06
FY07
FY08
FY09
FY10
FY11
20%
FY99
FY00
FY01
FY02
FY03
FY04
FY05
FY06
FY07
FY08
FY09
FY10
Management of working capital and asset turnover Asset turnover for the company peaked in FY08 thus explaining ROE peaking the same year. However, since then slowing sales growth has led to significant fall off in the asset turnover, even as WC cycle continues to elongate. Working capital cycle has been worsening except for brief improvement in FY07-FY08. Receivables in particular have been key contributor to the deterioration.
FY11
75
October 12, 2011
Fig. 118: Asset turnover peaked in FY09 (same as ROE/ROCE) Fig. 119: and is now lower than previous lows
(x) (x)
2.1 2.0 1.9 1.8 1.7 1.6 1.5 1.4 1.3 Asset turnover
2.1 2.0 1.9 1.8 1.7 1.6 1.5 1.4 1.3 Asset turnover (ex cash)
FY99
FY00
FY01
FY02
FY03
FY04
FY05
FY06
FY07
FY08
FY09
FY10
FY99
FY00
FY01
FY02
FY03
FY04
FY05
FY06
FY07
FY08
FY09
FY10
FY11
Fig. 120: WC cycle has risen sharply and worse than Voltas
Days of revenue
90 80 70 60 50 40 30 20 10 0
FY99
FY00
FY01
FY02
FY03
FY04
FY05
FY06
FY07
FY08
FY09
FY10
Trajectory of growth Sales growth shows a pattern similar to asset turnover and suggests high correlation to cycle. Trend has been similar to Voltas directionally though volatility is much higher, in our view. EBITDA margin had improved continuously until FY10 and is now similar to FY99 levels.
FY11
FY11
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October 12, 2011
Fig. 121: Sales pattern highly correlated to business cycle

45% 40% 35% 30% 25% 20% 15% 10% 5% 0% -5%
Fig. 122: Delayed cyclicality in margins; better than Voltas

% of revenue
Sales growth
12% 11% 10% 9% 8% 7% 6% 5%
EBITDA margin
FY99
FY00
FY01
FY02
FY03
FY04
FY05
FY06
FY07
FY08
FY09
FY10
FY99
FY00
FY01
FY02
FY03
FY04
FY05
FY06
FY07
FY08
FY09
FY10
FY11

Sales trends are just now reviving (more of a base effect) from the post-Lehman collapse, while we notice a delayed impact on EBITDA margins.
Consensus estimates
Consensus EPS estimates for Blue Star are down 35-40% from peak levels compared to a 20-25% cutback in Voltas estimates.
Fig. 123: Consensus est. down sharply since peak
INR
35
Consensus EPS FY12
Consensus EPS FY13
30
25
20
Nov-10
Jan-10
Jun-10
Jan-11
Jun-11
Jul-10
May-10
May-11
Feb-10
Feb-11
Mar-10
Mar-11
Apr-10
Oct-10
Aug-10
Sep-10
Dec-10
Apr-11
Jul-11
15
Source: Bloomberg
Aug-11
FY11
77
October 12, 2011
Consensus valuation
The stock is trading almost at the 12 year average P/E and P/BV multiples.
Fig. 124: Significant de-rating already
Blue Star 1 year forward P/E chart (x)
Fig. 125: but valuations still reflective of mid-cycle

Blue Star 1 year forward P/BV chart (x)
30 25 20 15 10 5 0
16 14 12 10 8 6 4 2
Mar-00
Mar-01
Mar-02
Mar-03
Mar-04
Mar-05
Mar-06
Mar-07
Mar-08
Mar-09
Mar-10
Mar-11
Mar-00
Mar-01
Mar-02
Mar-03
Mar-04
Mar-05
Mar-06
Mar-07
Mar-08
Mar-09
Mar-10
Summary
Blue Star stock underperformed overall markets 31% over the past 12 months. Asset turnover, return ratios and working capital cycle are close to the bottom Blue Star shows similar trends as that of Voltas but the volatility is high. Blue Star also enjoys higher margins compared to Voltas. We also notice sharp contrast in the way WC cycle has been managed by Blue Star as against a very tight rein displayed by Voltas. Tight control over the WC cycle has allowed Voltas to keep a check on its asset turnover as well as return ratios. Consensus estimates are sharply down by around 35-40% since peak. Blue Stars 12-year mean P/E multiple at ~12x is in line with Voltas, while on P/BV it is 4x vs. 3.5x for Voltas. Currently, Voltas is trading below the 12-year mean multiples, as discussed above.
Mar-11
78
October 12, 2011
79
October 12, 2011
80
October 12, 2011
Appendix A-1
Analyst Certification
We, Amar Kedia and Indrajit Yadav, hereby certify (1) that the views expressed in this Research report accurately reflect our personal views about any or all of the subject securities or issuers referred to in this Research report, (2) no part of our compensation was, is or will be directly or indirectly related to the specific recommendations or views expressed in this Research report and (3) no part of our compensation is tied to any specific investment banking transactions performed by Nomura Securities International, Inc., Nomura International plc or any other Nomura Group company.
Issuer Specific Regulatory Disclosures

Mentioned companies
Issuer name ABB India Bharat Heavy Electricals Crompton Greaves Cummins India Thermax Voltas Ticker ABB IN BHEL IN CRG IN KKC IN TMX IN VOLT IN Price INR 664 INR 332 INR 152 INR 410 INR 417 INR 101 Price date 10-Oct-2011 10-Oct-2011 10-Oct-2011 10-Oct-2011 10-Oct-2011 10-Oct-2011 Stock rating Reduce Neutral Buy Neutral Buy Buy Sector rating Not rated Not rated Not rated Not rated Not rated Not rated Disclosures
Previous Rating
Issuer name ABB India Bharat Heavy Electricals Crompton Greaves Cummins India Thermax Voltas Previous Rating Neutral Reduce Not Rated Buy Neutral Not Rated Date of change 30-Sep-2010 11-Oct-2011 09-Feb-2010 12-Aug-2010 11-Oct-2011 20-Sep-2010
Rating and target price changes

Ticker Old stock rating New stock rating Old target price New target price
ABB India Bharat Heavy Electricals Thermax Voltas
ABB IN BHEL IN TMX IN VOLT IN
Reduce Reduce Neutral Buy
Reduce Neutral Buy Buy
INR 585 INR 346 INR 645 INR 234
INR 525 INR 332 INR 500 INR 150
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October 12, 2011
Important Disclosures
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Nomura Equity Research is available on nomuranow.com, Bloomberg, Capital IQ, Factset, Reuters and ThomsonOne. Important disclosures may be accessed through the left hand side of the Nomura Disclosure web page http://go.nomuranow.com/research/globalresearchportal or requested from Nomura Securities International, Inc., on 1-877-865-5752. If you have any difficulties with the website, please email grpsupport-eu@nomura.com for technical assistance. The analysts responsible for preparing this report have received compensation based upon various factors including the firm's total revenues, a portion of which is generated by Investment Banking activities. Unless otherwise noted, the non-US analysts listed at the front of this report are not registered/qualified as research analysts under FINRA/NYSE rules, may not be associated persons of NSI, and may not be subject to FINRA Rule 2711 and NYSE Rule 472 restrictions on communications with covered companies, public appearances, and trading securities held by a research analyst account. Industry Specialists identified in some Nomura International plc research reports are employees within the Firm who are responsible for the sales and trading effort in the sector for which they have coverage. Industry Specialists do not contribute in any manner to the content of research reports in which their names appear. Marketing Analysts identified in some Nomura research reports are research analysts employed by Nomura International plc who are primarily responsible for marketing Nomuras Equity Research product in the sector for which they have coverage. Marketing Analysts may also contribute to research reports in which their names appear and publish research on their sector.
Distribution of ratings (US)

The distribution of all ratings published by Nomura US Equity Research is as follows: 39% have been assigned a Buy rating which, for purposes of mandatory disclosures, are classified as a Buy rating; 8% of companies with this rating are investment banking clients of the Nomura Group*. 54% have been assigned a Neutral rating which, for purposes of mandatory disclosures, is classified as a Hold rating; 3% of companies with this rating are investment banking clients of the Nomura Group*. 7% have been assigned a Reduce rating which, for purposes of mandatory disclosures, are classified as a Sell rating; 0% of companies with this rating are investment banking clients of the Nomura Group*. As at 30 September 2011. *The Nomura Group as defined in the Disclaimer section at the end of this report.
Distribution of ratings (Global)

The distribution of all ratings published by Nomura Global Equity Research is as follows: 49% have been assigned a Buy rating which, for purposes of mandatory disclosures, are classified as a Buy rating; 41% of companies with this rating are investment banking clients of the Nomura Group*. 41% have been assigned a Neutral rating which, for purposes of mandatory disclosures, is classified as a Hold rating; 50% of companies with this rating are investment banking clients of the Nomura Group*. 10% have been assigned a Reduce rating which, for purposes of mandatory disclosures, are classified as a Sell rating; 20% of companies with this rating are investment banking clients of the Nomura Group*. As at 30 September 2011. *The Nomura Group as defined in the Disclaimer section at the end of this report.
Explanation of Nomura's equity research rating system in Europe, Middle East and Africa, US and Latin America for ratings published from 27 October 2008
The rating system is a relative system indicating expected performance against a specific benchmark identified for each individual stock. Analysts may also indicate absolute upside to target price defined as (fair value - current price)/current price, subject to limited management discretion. In most cases, the fair value will equal the analyst's assessment of the current intrinsic fair value of the stock using an appropriate valuation methodology such as discounted cash flow or multiple analysis, etc. STOCKS A rating of 'Buy', indicates that the analyst expects the stock to outperform the Benchmark over the next 12 months. A rating of 'Neutral', indicates that the analyst expects the stock to perform in line with the Benchmark over the next 12 months. A rating of 'Reduce', indicates that the analyst expects the stock to underperform the Benchmark over the next 12 months. A rating of 'Suspended', indicates that the rating, target price and estimates have been suspended temporarily to comply with applicable regulations and/or firm policies in certain circumstances including, but not limited to, when Nomura is acting in an advisory capacity in a merger or strategic transaction involving the company. Benchmarks are as follows: United States/Europe: Please see valuation methodologies for explanations of relevant benchmarks for stocks (accessible through the left hand side of the Nomura Disclosure web page: http://go.nomuranow.com/research/globalresearchportal);Global Emerging Markets (ex-Asia): MSCI Emerging Markets ex-Asia, unless otherwise stated in the valuation methodology. SECTORS A 'Bullish' stance, indicates that the analyst expects the sector to outperform the Benchmark during the next 12 months. A 'Neutral' stance, indicates that the analyst expects the sector to perform in line with the Benchmark during the next 12 months. A 'Bearish' stance, indicates that the analyst expects the sector to underperform the Benchmark during the next 12 months. Benchmarks are as follows: United States: S&P 500; Europe: Dow Jones STOXX 600; Global Emerging Markets (ex-Asia): MSCI Emerging Markets ex-Asia.
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October 12, 2011
Explanation of Nomura's equity research rating system for Asian companies under coverage ex Japan published from 30 October 2008 and in Japan from 6 January 2009
STOCKS Stock recommendations are based on absolute valuation upside (downside), which is defined as (Target Price - Current Price) / Current Price, subject to limited management discretion. In most cases, the Target Price will equal the analyst's 12-month intrinsic valuation of the stock, based on an appropriate valuation methodology such as discounted cash flow, multiple analysis, etc. A 'Buy' recommendation indicates that potential upside is 15% or more. A 'Neutral' recommendation indicates that potential upside is less than 15% or downside is less than 5%. A 'Reduce' recommendation indicates that potential downside is 5% or more. A rating of 'Suspended' indicates that the rating and target price have been suspended temporarily to comply with applicable regulations and/or firm policies in certain circumstances including when Nomura is acting in an advisory capacity in a merger or strategic transaction involving the subject company. Securities and/or companies that are labelled as 'Not rated' or shown as 'No rating' are not in regular research coverage of the Nomura entity identified in the top banner. Investors should not expect continuing or additional information from Nomura relating to such securities and/or companies. SECTORS A 'Bullish' rating means most stocks in the sector have (or the weighted average recommendation of the stocks under coverage is) a positive absolute recommendation. A 'Neutral' rating means most stocks in the sector have (or the weighted average recommendation of the stocks under coverage is) a neutral absolute recommendation. A 'Bearish' rating means most stocks in the sector have (or the weighted average recommendation of the stocks under coverage is) a negative absolute recommendation.
Explanation of Nomura's equity research rating system in Japan published prior to 6 January 2009 (and ratings in Europe, Middle East and Africa, US and Latin America published prior to 27 October 2008)
STOCKS A rating of '1' or 'Strong buy', indicates that the analyst expects the stock to outperform the Benchmark by 15% or more over the next six months. A rating of '2' or 'Buy', indicates that the analyst expects the stock to outperform the Benchmark by 5% or more but less than 15% over the next six months. A rating of '3' or 'Neutral', indicates that the analyst expects the stock to either outperform or underperform the Benchmark by less than 5% over the next six months. A rating of '4' or 'Reduce', indicates that the analyst expects the stock to underperform the Benchmark by 5% or more but less than 15% over the next six months. A rating of '5' or 'Sell', indicates that the analyst expects the stock to underperform the Benchmark by 15% or more over the next six months. Stocks labeled 'Not rated' or shown as 'No rating' are not in Nomura's regular research coverage. Nomura might not publish additional research reports concerning this company, and it undertakes no obligation to update the analysis, estimates, projections, conclusions or other information contained herein. SECTORS A 'Bullish' stance, indicates that the analyst expects the sector to outperform the Benchmark during the next six months. A 'Neutral' stance, indicates that the analyst expects the sector to perform in line with the Benchmark during the next six months. A 'Bearish' stance, indicates that the analyst expects the sector to underperform the Benchmark during the next six months. Benchmarks are as follows: Japan: TOPIX; United States: S&P 500, MSCI World Technology Hardware & Equipment; Europe, by sector Hardware/Semiconductors: FTSE W Europe IT Hardware; Telecoms: FTSE W Europe Business Services; Business Services: FTSE W Europe; Auto & Components: FTSE W Europe Auto & Parts; Communications equipment: FTSE W Europe IT Hardware; Ecology Focus: Bloomberg World Energy Alternate Sources; Global Emerging Markets: MSCI Emerging Markets ex-Asia.
Explanation of Nomura's equity research rating system for Asian companies under coverage ex Japan published prior to 30 October 2008
STOCKS Stock recommendations are based on absolute valuation upside (downside), which is defined as (Fair Value - Current Price)/Current Price, subject to limited management discretion. In most cases, the Fair Value will equal the analyst's assessment of the current intrinsic fair value of the stock using an appropriate valuation methodology such as Discounted Cash Flow or Multiple analysis etc. However, if the analyst doesn't think the market will revalue the stock over the specified time horizon due to a lack of events or catalysts, then the fair value may differ from the intrinsic fair value. In most cases, therefore, our recommendation is an assessment of the difference between current market price and our estimate of current intrinsic fair value. Recommendations are set with a 6-12 month horizon unless specified otherwise. Accordingly, within this horizon, price volatility may cause the actual upside or downside based on the prevailing market price to differ from the upside or downside implied by the recommendation. A 'Strong buy' recommendation indicates that upside is more than 20%. A 'Buy' recommendation indicates that upside is between 10% and 20%. A 'Neutral' recommendation indicates that upside or downside is less than 10%. A 'Reduce' recommendation indicates that downside is between 10% and 20%. A 'Sell' recommendation indicates that downside is more than 20%. SECTORS A 'Bullish' rating means most stocks in the sector have (or the weighted average recommendation of the stocks under coverage is) a positive absolute recommendation. A 'Neutral' rating means most stocks in the sector have (or the weighted average recommendation of the stocks under coverage is) a neutral absolute recommendation. A 'Bearish' rating means most stocks in the sector have (or the weighted average recommendation of the stocks under coverage is) a negative absolute recommendation.
Target Price
A Target Price, if discussed, reflect in part the analyst's estimates for the company's earnings. The achievement of any target price may be impeded by general market and macroeconomic trends, and by other risks related to the company or the market, and may not occur if the company's earnings differ from estimates.
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ANCHOR REPORT

India capital goods

Assessing earnings risk

India capital goods

ANCHOR REPORT: Assessing earnings risk

October 12, 2011

Prices as of 7th October. Source: Nomura Estimates

Rating: See report end for details of Nomuras rating system.

Nomura | India capital goods

October 12, 2011

Nomura | India capital goods

October 12, 2011

Nomura | India capital goods

October 12, 2011

Fig. 3: Commodity price Index (CRY Index)

Source: CEIC, Nomura Global Economics

Fig. 4: Repo rate (%)

Fig. 5: Short-term interest rate (%)

Nomura | India capital goods

October 12, 2011

4,500 3,600 2,700 1,800 900 0

BSE500 Oil & gas Auto & Auto Parts Power

Infra Telecom Cement Metals

7,000 6,000 5,000 4,000 3,000 2,000 1,000 0

Source: Ace Equity, Nomura research

Nomura | India capital goods

October 12, 2011

Our preferred picks: CRG, TMX and VOLT

Source: Nomura research

Nomura | India capital goods

October 12, 2011

20% 15% 10% 5% 0% 0% 5% 10% 15%

ABB CRG VOLT

0.4 0.4 0.7 1.0 1.3 1.6

Nomura | India capital goods

October 12, 2011

Nomura | India capital goods

October 12, 2011

Sector valuation summary

FY11 14.9 101.6 19.5 10.7 13.1 15.9 10.9 14.2

325 666 406 149 418 1,393 105

837 219 311 468 1,519 148 222

33.1 30.2 16.1 8.7 15.2 8.1 12.4 16.1

# of Recommendations Buy 21 0 12 19 14 34 19 3 4 4 4 8 4 3 Sell 4 34 7 14 6 3 3 9 6 2 0 0 1 3 Hold 15 2 3 11 15 3 5 6 3 3 0 1 2 6

Source: Bloomberg, Nomura estimates

Nomura | India capital goods

October 12, 2011

Fig. 14: Earnings estimates: Nomura vs consensus (Rs mn)

Consensus Difference Nom ura Consensus Difference

Source: Bloomberg, Nomura estimates

Nomura | India capital goods

October 12, 2011

Nomura | India capital goods

October 12, 2011

Source: CEIC and Nomura Global Economics. Units: % y-o-y

Bharat Heavy Electricals

No relief in sight, but reaching fair valuation

Nomura | Bharat Heavy Electricals

October 12, 2011

Key data on Bharat Heavy Electricals

43,034 73 43,106 -13,321 29,786

53,552 6,562 60,114 -17,841 42,273

65,194 0 65,194 -20,213 44,980